PRINCIPLES  OF  BUSINESS 


BY 

CHARLES  W.  GERSTENBERG 

PROFESSOR    OF    FINANCE    IN    NEW    YORK    UNIVERSITY 

AUTHOR   OF    "materials   OF   CORPORATION    FINANCE," 
"law      OF      BANKRUPTCY,"     "ORGANIZATION 
AND   CONTROL,"    "PERSONAL    POWER 
mS^  IN    BUSINESS,"    ETC. 


THIRD  EDITION— REVISED 


443'-)8 


NEW   YORK 

PRENTICE-HALL,  Inc. 

1922 


Copyright,  1918,  1922,  by 
PRENTICE-HALL,  Inc. 


All  Rights  Reserved 


53  51 

PREFACE 

This  book  I  have  written  for  the  experienced  business 
(  man  and  for  the  young  man  just  stepping  out  into  busi- 
^  ness  life. 

,  The  man  of  experience  will  read  it,  I  think,  because  his 
experience  has  gradually  made  him  a  specialist  in  certain 
phases  of  business  activity  and  has  limited  his  outlook  to 
those  things  which  from  day  to  day  he  is  compelled  to  do. 
He  needs  to  have  his  vision  broadened,  to  be  taken  out  of 
^l  the  rut  of  everyday  duties  and  to  be  shown  the  business 
rpj'machine  as  a  whole. 

The  book  is  offered  the  young  student  on  the  ground 

that  we  see  an  object  in  its  entirety  before  we  begin  to 

see  its  details.     First,  we  see  the  building,  then  the  doors 

and  windows,  then  the  details  of  design  about  the  doors 

^  and  windows,  and  last  we  bring  all  the  elements  together 

^  again  and  see  how  they  are  related  to  one  another  and 

"^perform  their  functions  in  making  the  building  accom- 

^  plish  the  purposes  for  which  it  stands. 

Moreover,  the  young  student  should  have  his  new 
studies  connected  with  his  studies  in  the  sciences  and  arts 
that  have  been  pursued  in  the  preparatory  school  or  in 
the  University  college  of  pure  arts  and  sciences.  Busi- 
ness, after  all,  consists  in  turning  all  of  man's  knowledge 
and  power  to  the  end  of  making  profits.  I  am  fond  of 
paraphrasing  Henry  Ward  Beecher's  definition  of  ora- 
tory— "truth  pressed  home  with  all  the  resources  of  the 
living  man'' — thus,  business  is  profits  brought  home  with 
all  the  resources  of  the  livinsr  man.     For  this   reason 


iv  PREFACE 

business  science,  in  this  book,  is  not  conceived  as  knowl- 
edge of  the  narrow  fields  of  production,  marketing, 
finance  and  accounting,  but  as  a  science  whose  relation 
to  the  other  sciences  is  so  intimate  that  the  division  line 
between  them  is  hard  to  draw.  In  the  first  part  of  the 
book,  then,  will  be  found  a  discussion  of  scientific  method 
generally  as  it  may  be  applied  to  business,  and  also  a 
brief  treatment  of  the  debt  which  business  owes  to  chem- 
istry, engineering,  the  natural  and  the  social  sciences. 

Had  it  not  been  for  the  assistance  of  friends  and  col- 
leagues I  should  never  have  attempted  to  bring  the  whole 
science  of  business  within  the  scope  of  a  single  volume. 
Their  work  has  been  indispensable.  To  my  colleague, 
Mr.  Gould  L.  Harris,  and  to  Mr.  Henry  Brach,  C.P.A., 
I  am  indebted  for  assistance  in  the  chapter  on  Account- 
ing, and  to  Mr.  William  Longino  for  the  chapters  on 
Advertising  and  Traffic.  Professor  Richard  P.  Ettinger 
has  read  the  manuscript  and  given  valuable  suggestions 
for  improvement.  Messrs.  J.  W.  Stannard,  of  the  Stand- 
ard Parts  Company,  Louis  M.  Levine,  with  Ladenburg, 
Thalmann  and  Company,  and  Mr.  E.  E.  Jackson,  have 
helped  in  the  construction  of  the  book  at  one  point  or 
another.  But  to  Mr.  John  L.  Sinclair,  who  has  been  un- 
tiring in  his  assistance  and  whose  criticisms  while  always 
kindly  have  never  been  superficial  or  lacking  in  discern- 
ment, I  am  chiefly  indebted  for  whatever  the  book  con- 
tains that  may  commend  itself  to  the  business  man,  the 
business  student,  or  the  business  teacher. 

C.  W.  G. 


CONTENTS 

CHAPTER  PAGE 

I  The  Science  of  Business i 

What  is  business — The  science  of  business — The  Scien- 
tific spirit  in  business — Content  of  the  science  of  busi- 
ness— The  environment  of  business — Kinds  of  business 
— The  true  nature  of  business — Securing  profits. 

II  The  Environment  of  Business     ....      12 

The  sciences — The  pure  sciences — Physics  and  chemis- 
try— Other  natural  sciences — Summary. 

III  The  Social  Sciences 22 

The  place  of  the  social  sciences  in  the  science  of  busi- 
ness— What  are  the  social  sciences — The  shortcomings 
of  the  social  sciences — The  services  of  the  social  sci- 
ences to  human  arts — History— What  are  the  respective 
fields  of  economics,  sociology  and  ethics? 

IV  The  Social  Sciences  (Continued)      ...      38 

Sociology — What  can  sociology  do  for  business? — Prac- 
tical sociological  work — Value  of  maintenance  work — 
Economics — The  three  phases  of  socialization  of  indus- 
try— Early  history  of  economic  science — Relation  of 
classical  school  to  practical  life — Criticism  of  the  class- 
ical school—Modern  economics^Political  science  and 
business — The  right  of  freedom  of  contract — History  of 
the  "police  power" — Government  and  business  during 
the  war — Effect  of  war  on  social  activities — The  future 
of  Government  relation  to  business — The  Government 
as  a  promoter  of  business — Business  men  and  the  law 
— Substantive  and  adjective  law — Law  and  equity;  com- 
mon law  and  statute  law — Experts. 

V  The  Scientific  Method 63 

What  is  meant  by  "the  scientific  method"?— The  collec- 
tion of  facts — Causes  of  mal-obscrvation — Testing  ob- 
servations— Difficulties  of  experimenting  with  complex 
facts — Progress  of  experimentation  in  business — Mem- 
ory—Testimony— Importance  of  reading  by  pages — 
Testimony  in  modern  business  education — Making  in- 
ferences— Verification — Hasty       conclusions — Deduction 

V 


vi  CONTENTS 

CHAPTER  PAGE 

presupposes  analysis — Importance  of  analysis  of  busi- 
ness problems — The  importance  of  scientific  methods — 
Analysis — Analysis  should  be  sufficiently  detailed — An- 
alysis the  basis  of  "scientific  management" — Clasifica- 
tion  and  definition — Kinds  of  classification — Classifica- 
tion into  genus  and  species — Definition — Importance  of 
selecting  proper  class — Importance  of  classification  and 
definition  in  business — Importance  of  authority  in  fram- 
ing definitions — Where  authority  to  define  may  be 
found — Importance  of  understanding  the  sense  in  which 
a  word  is  used — Some  typical  classifications  in  busi- 
ness— The  Interstate  Commerce  Commission's  Classifi- 
cation of  Accounts — Rules  of  scientific  classification. 

VI  Forms  of  Business  Enterprises  ....     104 

Importance  of  the  form  of  organization — Various  forms 
of  organization — The  individual  proprietorship — The 
general  partnership — Advantages  and  disadvantages  of 
partnership — The  joint-stock  company — Associations 
formed  under  deeds  of  trust — Advantages  of  trusts — 
The  corporation — Organization  and  control  of  corpora- 
tion— Classes  of  ownership — Voting  trusts — Consolida- 
tions— Consolidation  through  stockholding. 

VII  Financing 119 

/Importance  of  correct  methods  of  finance — Promotion 
— Promoter's  calculations — Estimating  gross  income — 
Calculating  operating  expenses — Estimating  the  capital 
expenses — Promotion  expenses — Construction  expenses 
— Assembling — Working  capital — Changes  in  working 
capital — Seasonal  variations  in  working  capital — Capital 
for  expansion — Selling  additional  stock — Borrowing 
funds — When  to  borrow — Borrowing  from  the  inves- 
tors— Choice  of  bonds — The  corporate  mortgage — Mod- 
ern bond-financing — Advantage  of  large  issues — Finan- 
cing subsidiaries — Regulating  the  income  on  bonds — 
The  amount  of  bonds  that  can  be  sold — When  to  sell 
securities  —  Nine-hundred-and-ninety-nine-ycar  bonds  — 
Redeemable  bonds — Short-term  notes — Extinction  of  in- 
debtedness— Sinking  funds  and  serial  bonds — Conver- 
sion of  bonds — Methods  of  selling  securities — Under- 
writing syndicates — Stock  exchange  as  an  aid — Prospec- 
tuses— "Catch-phrase"  financial  advertising — "Blue  sky" 
legislation — Money-raising  and  money-making. 

VIII  Financing  (Continued)     ......     159 

Control  of  income — Maintenance — Taxation — Creation 
of  surplus — Law  of  dividends — Expediency  in  payment 


CONTENTS  vii 

CHAPTER  PAGE 

of  dividends — Dividends  and  stockholders — Stability  of 
dividends — Reserve  policies — Dividends  and  cash — 
Scrip,  stock  and  property  dividends — Capitalization  and 
recapitalization. 

IX  Financing  (Continued) 170 

Readjustments — Causes  of  failure — Embarrassment,  in- 
solvency and  bankruptcy — Remedies  for  insolvency — 
Receiverships — Settlements  with  creditors — Going  into 
bankruptcy — 'Compositions  with  creditors — Who  gets 
an  insolvent  debtor's  property  ? — Reorganization — Pur- 
poses of  reorganization — Obviating  the  difficulties — Fur- 
nishing funds — Forcing  funds — Technique  of  reorgani- 
zation— Providing  a  good  management. 

X  Management 183 

The  problem  of  management — Location  of  plant — Unity 
of  control  essential  in  management — The  distribution  of 
managerial  authority — The  "line"  type  of  organization — 
Division  of  labor  in  the  line  organization — Records  in 
the  line  organization — Summary — Line-and-staff  organi- 
zation— Department  organization — The  committee  of 
legislative  management  type — The  suggestion  system — 
functional  organization — Functional  organization  in 
shop  work — Receiving  the  order — The  route  clerk — 
The  instruction-card  man — The  gang  boss — The  speed 
boss — The  inspector — The  repair  boss — The  disciplin- 
arian— "Lost  motion"  eliminated — Why  increase  of  out- 
put is  profitable — Installation  of  a  functional  system — 
The  four  basic  departments — The  financial  depart- 
ment— the  production  department — The  sales  depart- 
ment— The  accounting  department — The  problems  in- 
volved in  organization. 

XI  Management  (Continued) 218 

Primitive  management— Record-keeping  management — 
Systematized  management — Rules  for  good  reports — 
Contents  of  reports — The  Taylor  system — What  is 
meant  by  the  term  "scientific  management" — The  prelim- 
inary stages  of  scientific  management — The  "one  best 
way" — Standardization  of  the  operation,  or  formulation 
of  the  standard  task — Time-and-motion  study — Pres- 
ervation of  knowledge  gained  by  time-and-motion 
study — Standardization — Standardization  as  a  national 
habit — Fitness  of  the  workman — The  spirit  of  co- 
operation— A  "wage  of  contentment" — Leadership — The 
new  view-point — "Under  new  management." 


viii  CONTENTS 

CHAPTER  PAGE 

XII  Office  Management 247 

Office  management  defined — Office  duties — Lay-out  of 
the  office — Lighting — Noise — Office  furniture  and  equip- 
ment— Providing  an  efficient  office  force — Classification 
of  office  tasks — Incoming  communications — Outgoing 
communications  —  Interdepartmental  communications — 
Standardized  forms  of  records  and  reports — Assemblage 
of  data — Filing — Classification  before  filing — Flat  and 
vertical  filing — Filing  systems — The  Dewey  decimal 
system — Disposing  of  obsolete  data — The  tickler  file — 
The  card  index — Business  libraries — Standard  catalogue 
sizes — The  assigning  of  office  tasks. 

XIII  Wages 270 

Definition  of  wages — The  products  of  industry — Distri- 
bution of  the  products  of  industry — High  productivity 
means  high  wages — The  limits  of  wages— What  is  a 
fair  wage — Wage-policies  of  capital,  labor  and  the 
public — Wage-policies  of  capital — ^^Wage-policies  of  the 
labor-unions  and  labor  policies  of  the  public — Labor 
and  the  war-— Publicity  as  a  corrective  of  labor  troubles. 

XIV  Wage  Systems 287 

Wages  from  the  employer's  point  of  view — Wages  an- 
alyzed— Three  kinds  of  wages — Time  wages — Service- 
wages — The  sliding  scale — Rate-of-service  wages — The 
Halsey  system — The  Rowan  plan — The  Taylor  differen- 
f  tial  piece-rate— The  Gantt  "task  and  bonus"  system — 
The  Emerson  "efficiency"  system — The  Ford  system — 
Essentials  of  a  sound  wage-system — Necessity  for  stand- 
ardization and  classification  of  jobs — The  Westinghouse 
classification  system— Trade-unions — Collective  bargain- 
ing, how  accomplished— Non-union  collective  bargain- 
ing. 

XV  The  Control  of  Labor 320 

The  control  of  industry — Centralization  of  control  is 
essential — What  is  meant  by  the  control  of  labor — If 
labor  surrenders  control,  how  may  its  interests  be  pro- 
tected?— Wages  not  an  economic  cost — How  may  labor 
costs  be  reduced? — Improvements  in  machinery — Im- 
provements in  working  methods — Physical  capacity  of 
the  workman — Fatigue — Mental  fatigue — Measurement 
of  fatigue — Rest  and  sleep — The  eight-hour  day — Selec- 
tion and  training  of  employees — The  employment  de- 
partrnent — Securing  the  co-operation  of  employees. 


CONTENTS  ix 

CHAPTER  PAGE 

XVI  The  Control  of  Labor  (Continued)     .      .    344 

Continuity  of  employment  as  a  factor  in  labor  cost — 
The  problem  of  labor  turnover — Calculation  of  labor 
turnover — Causes  of  leaving  work — Classification  of 
causes  of  leaving  work — Standardization  of  practice  in 
computing  labor  turnover — Means  of  reducing  labor 
turnover — Maintenance  work  defined — Management  of 
employees'  benefit  associations — Group  insurance — Pro- 
fit-sharing— The  purpose  of  profit-sharing — Forms  of 
profit-sharing — A  typical  profit-sharing  plan — Effective- 
ness of  profit-sharing  plans — Ownership-sharing — Stock- 
Owning  bonus  plan  of  General  Motors — Housing — Cost 
of  housing — Reasons  for  undertaking  industrial  housing 
— Results  of  housing  activities — Why  maintenance  work 
in  general  has  been  undertaken — The  present  status  of 
maintenance  work. 

XVII  Purchasing ZJZ' 

The  purchasing  agent's  place  in  the  business  organiza- 
tion— The  scope  of  the  purchasing  agent's  authority — 
The  purchasing  agent  should  rank  with  the  sales  man- 
ager— Opportunities  open  to  the  purchasing  agent — 
Ability  and  opportunity  to  acquire  knowledge  and  to  use 
it  is  the  "secret"  of  power — The  purchasing  agent  learns 
the  methods  and  processes  of  other  businesses — The 
purchasing  agent  becomes  a  market  analyst,  concerned 
with  both  supply  and  demand — The  purchasing  agent 
deals  with  many  products  and  in  many  markets — Oppor- 
tunities of  the  purchasing  agent  to  introduce  cheaper 
and  more  serviceable  materials — The  purchasing  agent's 
service  to  the  country,  in  the  conservation  of  resources — 
The  purchasing  department— Analysis  of  purchase  re- 
quirements— Standardization  of  purchases — Schedulesof 
delivery — The  sources  of  supply — Purchase  requisi- 
tions— Purchasing  methods — Buying  by  specifications — 
Standard  specifications — Bargaining — Terms — The  com- 
petitive system  in  purchasing — Emergency  service — Rush 
orders — Purchase  orders — Saving  steps  in  purchasing — 
Securing  delivery — Receiving  the  goods — Inspection — 
Inspection  of  the  source — Return  of  defective  goods. 

XVIII  Selling 400 

The  point  of  view — What  is  a  need — how  ascer- 
tained— Consumers'  needs,  the  basis  of  profitable  sell- 
ing— The  consumer  pays — The  function  of  selling,  de- 
fined— The  high  cost  of  selling — Elements  of  the  selling 
cost — Why  selling  costs  are  high — The  elimination  of 
uncertainty — Objectives  of  the  seller — Knowledge  of  the 


X  CONTENTS 

CHAPTER  PAGE 

product  itself — Demand — Developed  demand — Undevel- 
oped demand — Forced,  or  natural  demand? — Continuity 
of  demand — Serviceability — Necessity,  or  luxury? — 
General,  or  special,  service? — Variety  of  uses — Dura- 
bility— Basis  of  appeal — Quality — Name  or  trade-mark — 
The  package — Determination  of  the  selling  price — An- 
alysis of  the  market — The  people  who  buy — Where  do 
they  live? — Environment — Classes  of  buyers — Buying 
habits — Competition — Transportation  in  its  relation  to 
the  market. 

XIX  Selling  (Continued) 430 

Salesmanship — What  is  meant  by  salesmanship — Sales- 
manship as  distinguished  from  advertising — The  basis 
of  successful  salesmanship — Making  a  sale — Attention — 
Interest — Desire — Action — The  support  of  the  "house" 
— Each  sale  a  problem  in  itself — The  "selling  talk" — 
Argument  and  suggestion — Management  of  salesmen — 
The  sales  organization — Leads — Sales  quota — The  re- 
sponsibility of  the  salesman — Energizing  the  selling 
force — Communications  between  the  house  and  the  sales- 
man— The  personality  of  the  house. 

XX  Selling  (Continued) 450 

Distribution — The  problem  of  distribution — The  disposal 
of  goods — The  "regular"  trade  channels — The  mer- 
chant— Exclusive  agencies — Branch  offices  or  stores — 
"Direct"  to  the  retailer — Manufacturers'  retail  stores — 
Chain  stores — Location  of  chain  stores — Standardiza- 
tion of  methods,  equipment  and  stock — Growth  of  the 
chain-store  movement — The  mail-order  house — Advan- 
tages of  mail-order  selling — Disadvantages  of  the  mail- 
order system — Mail-order  sales  methods — Mail-order  de- 
partments of  retail  stores — Mail-order  competition — The 
delivery  problem — Door  delivery — Highway  freight — 
Reducing  distribution  costs. 

XXI  Advertising 472 

Psychological  principles  of  effective  advertising — What 
attracts  attention — What  attracts  favorable  attention — 
what  arouses  interest — Curiosity,  one  example — Sug- 
gesting desire — Forcing  action. 

XXII  Traffic 483 

Distinction  between  traffic  and  transportation — The 
origin  of  transportation  charges — The  basis  of  carriers' 
rates — Rates  based  on  what  the  traffic  will  bear — Value 
of   the   commodity — Competition — Rates   based    on   cost 


CONTENTS  xi 

CHAPTER  PAGE 

of  service— Capitalization,  operating  and  overhead  ex- 
penses— Weight  and  density  of  commodities — Distance 
— Speed  of  transit — Amount — Direction — Classification 
— Commodity  rates — Shipping  papers — Bill  of  lading — 
Way  bill — Way  card — IDemurrage — Express  traffic — 
Parcel  post. 

XXIII  Foreign  Trade  and  Ocean  Traffic  .      .    504 

Balance  of  trade — Present  trend  in  our  foreign  trade — 
Future  trend  of  foreign  trade — Nature  of  exports — Na- 
ture of  imports — Economic  justification  of  foreign  trade 
— Developing  foreign  markets — Purchasing  power — 
Special  marketing  conditions — Bu3'ers — Sources  of  in- 
formation— Mediums  for  reaching  foreign  markets — 
The  packing  problem — Documentation — Kinds  of  bills 
of  lading — The  invoices — Other  papers — Ocean  traffic — 
Trade  routes — Types  of  vessels — Motive  power — Com- 
putation of  tonnage — Ocean  freight  rates — The  Mer- 
chant Marine  Act  of  1920 — Webb-Pomerene  Act — For- 
eign trade  financing — How  American  banks  can  do  a 
foreign  banking  business. 

XXIV  Credit 533 

Credit  as  a  factor  in  business — What  is  credit  ? — The 
uses  of  credit — Economic  considerations  in  credit-ex- 
tension— The  point  of  view  of  the  credit  grantor — 
Forms  of  credit — Credit  of  general  acceptability — Credit 
of  limited  acceptability — Book  accounts — Promissory 
notes  —  Bonds  —  Stock  certificates  —  Checks  —  Certi- 
fied checks — Cashiers'  checks — Bank  drafts^Bills  of  ex- 
change— Acceptances — Money  orders — -Travellers'  let- 
ters of  credit — Commercial  letters  of  credit — Classes  of 
credit — Kinds  of  credit  used  in  business  transactions — 
Investment  credit — Mercantile  credit — Banking  credit — 
Personal  credit — Credit  granted  by  the  retailer  to  the 
consumer — Credit  ratings — Who  is  entitled  to  credit — 
Sources  of  information  regarding  the  credit  applicant — 
General  agencies — Special  agencies — Merchants'  asso- 
ciations —  Information  from  salesmen  —  Information 
from  attorneys — Information  from  credit  men's  asso- 
ciations— Requirements  of  a  collections'  system — The 
tickler  system — Collection  from  slow-pay  customers — 
Credit  safeguards — The  credit  guaranty — Credit  insur- 
ance— The  credit  man. 

XXV  Forecasting  Business  Conditions       .      .     572 

The  importance  of  business  forecasting — Barometers — 
Business  cycles — Studying  fundamental  business  condi- 


xii  CONTENTS 

CHAPTER  PAGE 

tions — Possibility  of  accurate  forecasting — The  basis 
of  intelligent  forecasting — How  business  conditions  are 
measured — Barometers  of  production — Barometers  of 
distribution — Barometers  of  labor  conditions — Barome- 
ters of  business  profits — Barometers  of  the  exchanges 
— Barometers  of  the  money  market — Composite  barome- 
ters— Bibliography  of  forecasting. 

XXVI  Banking , 585 

Business  and  economic  services  of  banks — What  banks 
are  for — Public  credit  and  private  credit — The  nature 
and  origin  of  credit — The  available  supply  of  credit — 
Effective  credit — Summary— Banks  as  refiners  of  credit 
— Facilities  for  credit-exchange — The  nature  of  a  bank 
deposit — How  the  bank  makes  its  profit — The  distribu- 
tion of  credit — Credit  and  prices — Classification  of  busi- 
ness needs — Classification  of  banks — Industrial  banks — 
Investment  banks — Trust  companies — Savings  banks — 
Rural-credit  banks — Commercial  banks — The  purpose 
of  commercial  banks — Loans  and  discounts — Classes  of 
loans — Demand  loans — Time  loans — Acceptances — The 
line  of  credit — What  is  a  bankable  proposition? — The 
clearing  house — Private  commercial  banks — State  banks 
— National  banks. 

XXVII  Banking  (Continued) 631 

Bankers'  banks — Origin  of  the  Federal  Reserve  sys- 
tem— Disposition  of  earnings  of  Federal  Reserve  banks 
— Objects  of  the  Federal  Reserve  system — Member 
banks — Operation  of  the  Federal  Reserve  system — Re- 
serves of  reserve  banks  held  against  deposits — Reserves 
of  member  banks — Authorization  and  issue  of  Federal 
Reserve  notes — Discount,  rediscount  and  purchase  of 
commercial  paper — Paper  eligible  for  rediscount  or  pur- 
chase— Rediscounts — Paper  eligible  for  rediscount — 
—Promissory  notes — Trade  acceptances — Six  months' 
agricultural  paper — Commodity  paper — Bankers'  accept- 
ances, defined — Bankers'  domestic  acceptances — Bankers' 
foreign  acceptances — Bankers'  foreign  acceptances 
drawn  for  the  purpose  of  furnishing  dollar  exchange — 
Open-market  operations  authorized — Bills  of  exchange 
and  trade  acceptances  in  open-market  operations — 
Bankers'  acceptances  in  open-market  operations. 

XXVIII  Exchange 660 

The  meaning  of  "exchange" — The  need  for  exchange 
— The  theory  of  exchange — The  "system"'  of  exchange 
— The  process  of  exchange — Domestic  bills  of  exchange 


CONTENTS  xiii 

CHAPTER  .  PAGE 

— Foreign  bills  of  exchange — Bankers'  bills — Letters  of 
credit — The  price  of  bills  of  exchange — The  rate  of  ex- 
change— Rates  of  exchange  on  important  countries — 
Exchange  and  the  balance  of  trade — Arbitraging — 
Dealers  in  foreign  exchange— Operations  in  foreign  ex- 
change— Exchange  on  silver-standard'  countries. 

XXIX  Principles  of  Accounting      ....    684 

What  is  accounting — Relation  of  accounting  to  eco- 
nomics, law  and  finance — History  of  accounting — Book- 
keeping principles — The  merchandise  account — Finan- 
cial statements — Books  of  original  entry — What  an  ac- 
counting system  is — The  ledger  and  the  trial  balance — 
Controlling  accounts — Single-entry  bookkeeping— Ac- 
counting principles — The  distinction  between  capital  and 
revenue — Deferred  charges  to  expense — The  anticipa- 
tion of  income — Valuation  of  assets — Depreciation — 
Depreciation  and  repairs — Obsolescence — Methods  of 
calculating  depreciation — Funds. 

XXX  Financial  Statements 714 

Old  methods  no  longer  satisfactory — Importance  of 
finahcial  statements  in  obtaining  and  granting  credit — 
Value  to  the  investor — Obligations  to  furnish  financial 
statements — The  balance  sheet — Importance  of  proper 
construction  of  the  balance  sheet — Form  of  balance 
sheet — Bank  statements — Valuation  of  assets — Balance 
sheet  is  a  statement  of  opinion — What  are  fixed  assets 
— Real  estate — Improvements  on  leased  ground — Valu- 
ation of  leasehold  rights — Wasting  assets — Cost  of 
buildings — Renewals,  repairs  and  betterments — Equip- 
ment— [Machinery  account — Furniture  and  fixtures — 
Patterns,  drawings  and  dies — Equipment  purchased  on 
the  partial  payment  plan — Intangible  assets — Good-will 
— Franchises — Patents,  trade-marks  and  copyrights — 
Treasury  stock — Current  assets — What  are  current  as- 
sets— Cash  in  banks — Cash  on  hand — Notes  receivable — 
Accounts  receivable — Investments  in  stocks  and  bonds — ■ 
Working  and  trading  assets — Inventories — Valuation  of 
merchandise — Deferred  charges  to  expense — What  are 
deferred  charges — Organization  expenses — Prepaid  ex- 
penses— Discounts  on  bonds — Analysis  of  liabilities — 
Liabilities  and  capital — Fixed  liabilities— Current  lia- 
bilities— Deferred  credits  to  income— Capital  and  sur- 
plus— Interpretation  of  balance  sheet — Comparative  bal- 
ance sheets — Analysis — The  income  statement — Value 
of  the  income  statement — Gross  income — Cost  of  Sales 
— Turnover — Selling    expenses — General    and    adminis- 


xiv  CONTENTS 

CHAPTER  PAGE 

trative  expenses — The  operating  ratio — Other  income 
■ — -Charges  against  income — Profit  and  loss  credits  and 
charges — Distribution  of  net  profits — Secret  reserves — 
Consolidated  statements. 

XXXI  Cost  Accounting 754. 

What  cost  accounting  is — Insufficiency  of  general 
accounting — Functions  and  uses  of  cost  system — The 
elements  of  cost — Direct  materials — Direct  materials 
often  treated  as  indirect  materials — Cost  of  materials — 
Direct  labor — Manufacturing  overhead — Allocation  of 
certain  expenses — Arguments  against  inclusion  of  inter- 
est in  cost — Cost  records — Material  records — Pricing  of 
material  requisitions — The  problem  of  by-products — 
Perpetual  inventories — Labor  records — The  distribution 
of  overhead — Direct-labor  cost — Advantages  and  dis- 
advantages of  direct-labor  cost  method — Direct-labor 
hours — Prime  cost — Old  machine-rate — Fixed  machine- 
rate — Administrative  charges  applicable  to  factory — 
Depreciation— Indirect  labor — Heat — Light — Insurance 
— Indirect  materials — Power — Rent— Repairs  and  main- 
tenance— Taxes— Interest — Standard  labor  hours — Idle 
time'  or  unearned  burden — Cost-records  and  general 
books — The  production  order  and  the  cost  sheet— ^Gen- 
eral ledger  accounts — Cost-controlling  accounts — Ma- 
chine-hour summary — General  overhead — Cost  records 
in  their  relation  to  the  selling  price — Essentials  of  cost 
forms. 

Index .    795 


PRINCIPLES  OF  BUSINESS 

CHAPTER  I 

THE  SCIENCE  OF  BUSINESS 

What  is  business? — It  would  seem  to  the  ordinary 
man  about  town  to  be  an  unnecessary  task  to  attempt 
to  define  a  term  so  commonly  used  as  the  word  "busi- 
ness." If  we  say  that  business  is  the  aggregate  of  all 
the  activities  whereby  man  makes  his  living,  or  if  we 
define  it  as  the  production  of  goods  and  services  and 
the  processes  whereby  they  are  made  useful  and  con- 
sumable, we  shall  probably  have  added  nothing  to  the 
clearness  with  which  we  commonly  think  of  the  word 
"business."  But  one  thing  we  can  make  quite  clear 
about  this  term,  and  to  do  so  will  help  in  large 
measure  to  explain  just  what  this  book  is  about. 
Business  is  a  group  of  activities-;  it  is  not  the  body  of 
rules  that  tell  how  those  activities  can  accomplish  the 
most  desirable  results.  When  we  speak  of  "baseball," 
for  example,  we  think  of  some  organized  activities  that 
make  up  the  game  of  baseball.  That  there  are  rules  to 
be  followed  in  playing  the  game  does  not  constitute  those 
rules  baseball.  Indeed  those  rules  generally  mean  that 
if  they  are  not  obeyed,  the  result  is  not  baseball,  but 
some  other  form  of  activity.  So  there  are  rules  that 
business  must  follow  or  the  result  will  be  not  business, 
but  some  other  activity.  In  a  simple  activity  like  base- 
ball, the  rules  can  easily  be  collected;  but  in  an  almost 


2  PRINCIPLES  OF   BUSINESS 

infinitely  complex  collection  of  activities  like  business, 
the  rules  are  not  simple,  nor  is  it  possible  to  formulate 
them  with  precision. 

The  science  of  business. — After  we  have  learned 
the  rules  for  playing  baseball  or  any  other  game, 
we  must  still  learn  how  to  play  the  game  well. 
As  different  contingencies  arise  in  the  game,  we 
learn  to  recognize  them  and  to  find  means  of  over- 
coming the  difficulties  they  present.  One  of  the  greatest 
advantages  of  scientific  method  applied  to  any  activity 
is  that  difficulties  may  be  anticipated.  We  can  save  the 
pound  of  cure  by  applying  the  ounce  of  prevention.  Com- 
pare, for  example,  the  untutored  game  of  baseball  played 
in  the  vacant  lot  with  the  scientific  game  played  by  the 
professional  clubs.  The  training  the  professionals  get 
enables  them  to  adjust  their  positions  on  the  field  the 
more  effectively  to  meet  the  probable  outcome  of  a  pres- 
ent condition.  Most  men  will  appreciate  this  argument 
if  they  will  recall  how  the  fielders  "lay  out"  when  a  heavy 
hitter  steps  to  the  plate  as  batter,  or  how  the  in-fielders 
move  up  nearer  to  the  plate  when  a  man  is  on  base  with 
no  players  out.^ 

Thus  gradually  we  collect:  a  body  of  rules  the  main 
purpose  of  which  is  not  to  tell  us  how  to  play  the  game, 
but  how  to  play  it  well.  In  golf,  for  example,  we  have 
such  rules  as,  keep  your  eye  on  the  ball,  keep  your  head 
down,  don't  sway  the  body,  and  the  like.  One  may  vio- 
late all  these  rules  and  still  play  golf.     Indeed  we  may 

^  An  excellent  application  of  this  principle  in  business  will  be 
found  in  an  article  entitled  "Anticipating  Buying  Emergencies," 
Iron  Age,  December  2,  1915,  pp.  1300-1302,  and  reprinted  in  Cope- 
land's  Business  Statistics,  pp.  411-417.  See  also  Jevons,  The  Prin- 
ciples of  Science. 


THE  SCIENCE  OF  BUSINESS  3 

find  exceptional  cases  where,  though  some  of  these  rules 
are  violated,  good  golf  is  played.  But  in  the  long  run, 
obedience  to  these  rules,  all  founded  on  the  basic  prin- 
ciples of  cause  and  effect,  will  produce  the  best  results. 
Now,  the  body  of  all  these  rules  for  playing  good  golf 
is  called  the  science  of  golf.  And  when  these  rules  are 
put  into  practice,  we  have  the  art  of  golf. 

Business  is  an  art.  But  it  has  its  corresponding 
science.  The  science  of  business  is  the  systematically 
arranged  knowledge  which  experience  has  taught  us  to 
apply  in  our  activities  if  we  would  be  successful.  A  dec- 
ade or  so  ago  the  idea  of  science  in  business  was  scoffed 
at.  Men  boasted  'of  being  "practical."  In  a  country  like 
the  United  States,  populated  with  free  and  intelligent  peo- 
ple demanding  many  things  and  with  ample  resources  to 
supply  those  demands,  it  was  easy  for  the  practical  man 
to  succeed.  Almost  anybody  can  catch  fish  in  a  stocked 
pond,  but  it  takes  an  expert  to  find  and  land  his  catch  in 
the  open  waters  where  fish  do  not  abound. 

"The  practical  man,"  said  Disraeli,  "is  the  man  who 
practises  the  errors  of  his  forefathers." 

The  scientific  spirit  in  business, — ^But  science  has 
already  accomplished  too  much  in  business  to  need  any 
defense.  When  business  became  a  matter  of  machinery 
as  well  as  of  crude  labor,  technically  trained  men  were 
drawn  into  its  activities  and  it  was  but  natural  that  theii 
.scientific  spirit  and  habits  should  gradually  affect  all 
■departments  of  business — even  those  in  which  the  tech- 
nical men  were  not  directly  concerned.  Moreover,  as 
business  units  of  activity  grew  in  size,  the  element  of 
waste,  though  relatively  perhaps  no  larger  than  it  was 


4  PRINCIPLES  OF  BUSINESS 

before,  became,  in  absolute  amount,  so  huge  that  busi- 
ness could  afford  to  hire  experts  to  study  and  analyze 
its  processes  in  order  to  detect  and  eliminate  the  waste. 
Gradually  almost  every  department  of  business  is  being 
subjected  to  the  processes  of  observation,  analysis  and 
synthesis  that  may  be  termed  the  essence  of  the  scientific 
spirit.  Not  only  do  we  have  "scientific  management" 
of  labor  in  shops,  but  we  are  getting  it  in  selling,  ad- 
vertising and  other  departments. 

Content  of  the  science  of  business. — It  behooves 
every  man  and  woman  in  business,  then,  to  learn  some- 
thing of  this  most  universally  useful  of  all  sciences,  the 
science  of  business.  Of  what  does  it  consist?  It  may 
be  said  to  consist  of  three  parts,  termed,  for  the  want 
of  better  names,  the  environment  of  business,  the  func- 
tions of  business  and  the  kinds  of  business.  Some  busi- 
ness men  will  need  to  know  more  about  certain  parts 
of  the  science  than  will  other  men,  or  than  they  them- 
selves will  need  to  know  about  other  parts  of  the  science. 
Let  us  see  in  broad  outline  of  what  each  of  these  three 
parts  of  the  science  of  business  consists. 

The  environment  of  business. — All  activities  of  man 
are  interrelated.  You  cannot  study  English,  or  physiol- 
ogy, or  yachting,  or  business  without  learning  something 
about  other  matters.  Some  activities  are  fairly  self- 
contained.  One  doesn't  need  a  wide  range  of  learning 
to  play  golf  or  tennis.  True,  one  might  make  a  very  deep 
study  of  the  mathematical  science  of  ballistics  an  ad- 
junct to  the  study  of  the  science  of  golf,  but  the  study 
would  be  of  relatively  small  practical  advantage.  On  the 
other  hand,   in  some  activities  a  fairly  wide   range  of 


THE  SCIENCE   OF  BUSINESS  5 

knowledge  is  directly  helpful.  Yachting,  for  example, 
will  easily  lead  one  into  a  study  of  navigation  with  all 
its  complexities  and  into  a  study  of  winds  and  tides  and 
geography  and  engineering  and  a  host  of  other  inter- 
esting subjects.  The  more  one  knows  of  some  of  these 
subjects  and  the  more  subjects  he  knows  at  least  some- 
thing about,  the  better  yachtsman  he  will  be.  If  we  were 
writing  a  book  on  the  science  of  yachting,  we  should 
have  to  deal  more  or  less,  depending  upon  the  detail 
with  which  we  were  treating  our  subject,  with  some  of 
these  surrounding  sciences. 

There  is  hardly  any  branch  of  human  knowledge  that 
does  not  have  a  potent  effect  somewhere  in  business  deal- 
ings. But  there  are  certain  branches  of  knowledge  which 
have  direct  and  almost  universal  application  in  business 
matters.  These  branches  we  may  call  the  environment 
of  business.  The  well-informed  business  man  will  have 
to  know  something  about  them.  In  the  next  chapter,  we 
shall  consider  the  more  important  branches  separately. 
Here  we  can  merely  indicate  in  a  general  way  that  the 
science  of  business,  as  we  conceive  it,  does  include  these 
outlying  sciences.  Just  as  the  physician  and  the  lawyer 
must  have  a  broad  training,  the  business  man  must  needs 
lay  the  roots  of  his  special  training  in  business  science 
and  practice  in  an  understanding  of  mathematics,  phys- 
ics, chemistry,  economics,  law,  history,  philology  and 
the  other  departments  of  human  knowledge. 

Functions  of  business. — Business  itself  consists  of 
the  production  of  goods  and  commodities,  and  of  their 
transportation  and  exchange.  To  study  these  things  is 
to  study  business  itself.     As  was  stated  in  the  preceding 


6  PRINCIPLES  OF  BUSINESS 

section,  we  cannot  study  any  one  of  these  processes  with- 
out gradually  working  off  into  other  sciences.  But  there 
are  certain  features  of  business  peculiar  to  itself,  which 
features,  taken  together,  we  may  call  the  functions  of 
business.  In  a  rough  way,  these  functions  may  be  divided 
into  four  parts  called  production,  marketing,  financing 
and  accounting. 

Production  includes  the  study  of  the  organization  and 
management  of  the  processes  required  to  transform  raw 
material  into  useful  commodities  and  simple  energy  into 
useful  services. 

Marketing  includes  the  study  of  all  the  means  whereby 
goods  are  exchanged  and  transported  from  one  owner 
to  another. 

Financing,  in  a  sense,  is  not  a  true  function  of  business, 
since  it  merely  facilitates  production  and  marketing;  and 
the  same  may  be  said  of  accounting.  Financing,  how- 
ever, may  be  defined  as  that  function  of  business  which 
facilitates  production  and  marketing  through  the  use  of 
funds.  And  accounting  may  be  said  to  be  that  function 
of  business  which  analyzes  the  other  functions  and  prop- 
erly records  the  results  of  the  analysis  to  the  end  that 
those  other  functions  may  be  intelligently  carried  on. 

There  may  be  elements  of  the  science  of  business  which 
are  generally  recognized  as  parts  of  the  science  of  busi- 
ness but  which  cannot  easily  be  fitted  into  any  one  of 
these  four  functions.  We  shall  find  little  difficulty,  haw- 
ever,  if  we  stick  close  to  our  definitions  as  given  above. 

Some  may  find  fault  with  our  classification  because 
it  does  not  make  administration  a  separate  function. 
Administration  is  nothing  other  than  a  composite  of  the 


THE  SCIENCE   OF  BUSINESS  7 

four  functions.  We  may  define  it  as  that  department  of 
business  which  directs  the  four  functions  of  producing, 
marketing,  financing  and  accounting.  If  we  regard  it  in 
this  light,  administration  does  not  require  a  separate 
treatment. 

Kinds  of  business. — There  are  certain  principles  ap- 
plicable solely  or  with  peculiar  force  to  certain  kinds  of 
business.  To  get  a  complete  grasp  of  the  entire  science 
of  business,  therefore,  we  must  study  separately  some 
of  the  more  important  kinds  of  businesses,  that  we  may 
understand  their  peculiar  principles.  Of  course  it  would 
be  impossible  to  make  a  study  of  every  separate  form 
of  business  enterprise,  but  the  broadly  trained  business 
man  ought  to  understand  the  principles  which  go\^rn 
those  undertakings  with  which  he  is  likely  to  come  into 
contact.  And  again,  other  businesses  should  be  studied, 
not  because  they  enter  directly  into  the  lines  and  activi- 
ties of  a  great  many  people,  but  because  their  processes 
are  so  old  or  are  conducted  on  such  a  large  scale  that 
they  must  become  a  matter  of  interest  to  every  well- 
informed  man. 

The  true  nature  of  business. — In  passing  to  a  de- 
tailed examination  of  the  science  of  business  we  must  not 
leave  the  reader  with  any  hazy  ideas  on  the  true  nature  of 
business,  and  so  we  will  pause  carefully  to  define  and  ex- 
plain the  term  business.  Business  ought  to  be  defined  as 
the  economic  activities  of  men  for  the  purpose  of  secur- 
ing profits  or  of  acquiring  property  rights. 

Economic  activities. — We  mean  by  economic  activi- 
ties the  activities  which  are  social  and  which  are  not 
anti-social.     There  was  no  business  in  the  davs  when  each 


8 


PRINCIPLES  OF  BUSINESS 


man  produced  the  goods  he  consumed.  It  may  have 
taken  a  great  amount  of  industry  to  acquire  the  goods 
that  were  to  be  used,  but  industry  alone  is  not  business. 
Business  implies  a  social  structure  organized  and  working 
as  a  unit  to  produce  its  goods.  Business  consists  essen- 
tially of  the  bargaining  within  this  social  structure  for 
the  purpose  of  gaining  profits — the  social  end  being  the 
satisfaction  of  society's  wants. 

Moreover,  the  word  "economic"  implies  that  business 
activities  are  not  anti-social.  Here  again  we  must  lay 
stress  on  the  fact  that  business  implies  free  bargaining. 
To  get  a  better  understanding  of  this  let  us  trace  back 
roughly  the  history  of  man's  efforts  to  satisfy  his  wants. 
We  can  do  this  best  with  a  set  of  simple  diagrams. 


A 

Argument 

B 

Prvper/t/ 

P 

W 

I 

I 

W 

P 

3arffainin(} 

ServJces 

E 

Per^  uasioTi 

E 

Property 

and 

jServfce^ 


The  above  figure  represents  crudely  what  is  taking 
place  today  in  business.  A  and  B  are  two  persons  coming 
into  business  relations.  Each  has  services  and  property 
— either  or  both — to  sell.  P  is  the  physical  self,  and 
upon  its  strength  and  virility  depends  the  strength  and 
keenness  of  the  will  (W)  and  of  tlie  intellect  (I)  and  the 
emotions  (E).  The  process  of  bargaining  takes  place 
through  appeals  to  the  intellect  (arguments)  and  to  the 
emotions  (persuasion),  the  purpose  being  to  overcome  the 
will  and  to  cause  the  person  to  act  in  respect  to  his  prop- 
erty or  services.  This  is  the  modern  stage  of  business — 
sometimes  called  the  credit  stage.     It  also  covers   the 


THE  SCIENCE   OF  BUSINESS 


next  earlier  stage  of  business  called  the  money  stage. 
But  back  of  the  money  stage  was  the  age  of  barter — the 
stage  when  goods  were  "swopped"  directly  for  goods. 
Now  the  word  "barter"  comes  from  the  old  French,  and, 
as  those  of  the  passing  generation  who  have  had  any  ex- 
perience with  old-fashioned  "horse  swopping"  may  well 
know,  means  "to  cheat."  In  this  stage  there  was  no  true 
free  bargaining.  Property  within  the  tribe  or  the  family 
was  generally  held  in  common  and  exchange  took  place 
w^hen  a  wandering  outsider  offered  some  exotic  goods  for 
necessary  food  or  raiment.  Since  all  outsiders  were 
looked  upon  as  barbarians,  it  was  felt  that  he  was  legiti- 
mate prey  for  a  hard  bargain  and  indeed,  it  was  expected 
that  he  would  reciprocate  the  feeling.  There  was  no  gen- 
eral social  structure  beyond  the  clan  or  tribe.  As  we  see 
in  the  next  diagram,  there  was  no  appeal  from  intellect 
to  intellect  and  no  genuine  appeal  from  emotion  to  emo- 
tion. There  was  really  a  circumventing  of  the  intellect 
and  of  the  will  by  misrepresentations  and  by  appeals  to 
the  baser  emotions. 

Business,  if  we  may  call  it  "business,"  of  the  type 
exemplified  here,  makes  little  or  no  contribution  to  the 
economic  and  social  well-being  of  the  community,  as 
does  the  modern  type  of  business,  which  engages  all  of 
the  highest  human  powers. 


A 

J^raud 

it  ions 

>S 

Pro^erfy 

P 

w 

I 

I 

W 

P 

ServJcQS 

E 

h^^,. 

E 

Property 


In  the  stage  of  industry  preceding  barter  we  had  very 
little  exchange.     Wants  were  satisfied  by  slaves.     Thus 


lO 


PRINCIPLES  OF  BUSINESS 


\vc  find  the  slave  receiving  bare  necessities  for  his  serv- 
ices/    Thus  we  have  the  following  diagram : 


Troperty, 


Services 


Finally  we  get  back  to  the  primitive  stage  when  there 
was  practically  no  industry,  each  man  killing  his  game 
and  each  woman  poking  about  for  her  edible  herbs.  What 
little  capital  the  man  had,  such  as  a  rudely  fashioned 
spear,  was  buried  with  him  at  his  death.-  This  stage 
merged  naturally  into  the  so-called  pastoral  stage  in  which 
men  bred  animals  as  a  more  certain  means  of  having  them 
when  needed  and  the  women,  instead  of  searching  for 
edible  plants,  cultivated  them  and  thus  made  a  start  in 
agriculture.  What  httle  property  exchanged  hands  did 
so  either  by  gift — families  and  tribes  held  property  in 
common — or  by  theft.  Thus  ^^'e  have  the  primitive  ex- 
change illustrated  as  follows : 


A 

-^^ 

B 

^^ 

p 

W 

I 

I 

W 

P 

E 

—^2^-. 

E 

Froperty 


"^  It  must  not  be  thought  for  a  moment  that  these  stages  of  busi- 
ness existed  in  sequence  in  all  places  of  the  earth.  There  was  a 
great  deal  of  overlapping.  Indeed,  as  those  who  are  acquainted  with 
geographical  studies  or  such  stories  as  those  of  Stewart  Edward 
White  well  know,  the  different  stages  of  business  and  industry  all 
exist  at  the  present  time  and  are  represented  in  different  parts  of 
the  world. 

^  Most  of  the  facts  for  this  history  are  obtained  from  Biicher's 
Evolution   of  Industry. 


THE  SCIENCE  OF  BUSINESS  ii 

Modem  business  has  nothing  to  do  with  theft,  with 
slavery  or  with  deception.  Modern  society  calls  such 
practices  criminal  and  discourages  them  not  only  by  law 
but  by  ostracism. 

Securing  profits. — Some  students  may  object  to  the 
apparent  narrowness  of  our  definition  of  business.  They 
will  object  to  it  on  the  ground  that  it  seems  to  point  to 
selfishness  and  to  self-seeking  and  makes  no  suggestion 
of  the  ulterior  purpose  of  satisfying  human  wants.  It 
is  precisely  here  that  we  can  make  a  distinction  between 
economics  "the  social  science  of  business"  and  what  we 
in  this  volume  have  called  the  "science  of  business."  Let 
the  economist  deal  with  the  social  aspects  of  business. 
The  business  man  is  concerned  as  a  business  man  with 
making  profits  and  with  acquiring  property  rights.  This 
does  not  mean,  however,  that  the  business  man  is  an  ex- 
tra-social being,  living  without  the  pale.  It  does  not 
mean  that  he  does  not  recognize  his  social  obligations  or 
that  he  does  not  know  that  whatever  injures  society  must 
injure  him. 

It  means  that  the  business  man  as  such  is  interested  in 
making  profits,  though  as  a  member  of  society  his  profit- 
making  must  not  injure  the  public  good.  In  the  long 
run.  the  business  man  who  makes  his  business  conform  to 
current  social  ideas  on  what  is  good  and  what  is  bad  for 
society,  will  make  the  most  profits.  Indeed,  it  may  be  in- 
sisted that  profits  acquired  by  practices  contrary  to  recog- 
nized current  social  standards  are  not  "profits  '  but  "loot." 

BIBLIOGRAPHY 

Shaw,  A.  W.,  An  Approach  to  Business  Problems. 
Norris  A.  Brisco,  Economics  of  Business. 
T.   Veblen,   The   Theory  of   Business  Enterprises. 
Adams,    H.    C,    Description    of    Industry,    an    Introduction     to 
Economics. 


CHAPTER   11 

THE  ENVIRONMENT  OF  BUSINESS 

The  sciences. — For  our  purposes,  a  complete  classi- 
fication of  the  sciences  would  be  an  unnecessary  task. 
The  following  table  is  sufficiently  complete,  for  the  reason 
that  in  this  book  we  are  concerned  only  with  the  im- 
portant problems  of  business  upon  which  certain  bodies 
of  information,  called  sciences,  can  possibly  throw  some 
light.  We  shall  examine  these  sciences  briefly  to  see 
what  they  hold  of  interest  to  the  well-informed  business 
man. 

Pure  sciences. — Logic,  Mathematics. 

Natural  sciences. — Physics,  Chemistry,  Astronomy, 
Geology,  Biology,  Botany  and  Zoology. 

Social  sciences. — History,  Economics,  Politics,  Juris- 
prudence, Sociology,  Psychology,  Ethics  and  Philology.^ 

The  pure  sciences. — Mathematics  and  logic  are  very 
old  sciences.  In  fact,  these  two  abstract  sciences  are 
very  closely  related;  "the  basis  of  logic  is  the  basis  of 
mathematics  also.""  They  are  the  sciences  of  clear  think- 
ing. Logic  is  less  directly  connected  with  business  than 
is  mathematics,  but  its  discussion  of  how  knowledge  is 

^There  is  much  justification  in  any  criticism  wliich  objects  to 
including  Psychology,  Ethics  and  Pliilology  in  the  social  sciences, 
though  the  inclusion  may  be  justified  on  other  grounds  than  con- 
venience. 

2  Lecture  on  Mathematics  by  Professor  C.  J.  Keysen  in  Co- 
lumbia University  Lectures  on  Science,  Philosophy  and  Art. 

12 


THE  ENVIRONMENT  OF  BUSINESS         13 

obtained,  of  how  laws  are  constructed,  and  of  how  errors 
and  fallacies  in  observation  and  reasoning  may  be  de- 
tected and  guarded  against  must  be  of  benefit  to  men  in 
every  path  of  life.  A  careful  study  of  logic  and  mathe- 
matics makes  for  straight  thinking.  Perhaps  we  are 
right  today  in  our  universities  in  avoiding  the  strict  dis- 
cipline of  the  mind  which  required  the  student  of  the 
eighteenth  century  to  burden  his  memory  with  the  weari- 
some nomenclature  of  formal  logic  and  to  test  his  talents 
on  useless  information.  But  certain  it  is  that  the  uni- 
versity students  of  those  days  were  closer  reasoners  than 
are  the  average  men  of  our  contemporary  colleges. 

In  a  comparatively  new  science,  like  that  of  business, 
in  which  the  laws  governing  its  phenomena  have  not 
been  generally  formulated  and  clearly  stated,  logic  is 
especially  important  in  pointing  out  the  workmanlike 
way  for  the  researcher  to  study  the  phenomena,  to  make 
proper  inferences,  formulate  plausible  hypotheses  as  to 
the  causes  and  consequences  of  these  phenomena  and  to 
proceed  to  verify  those  hypotheses  and  thus  deduce  the 
laws  of  the  science.^ 

Mathematics,  the  science  of  numbers,  has  a  direct  re- 
lation to  business.  It  is  of  universal  importance.  In 
its  lower  branch,  simple  arithmetic,  it  is  constantly  used 
by  the  laborer  and  the  greengrocer.  Algebra,  that 
branch  which  uses  arbitrary  symbols  in  place  of  concrete 
objects,  and  then  subjects  them  to  all  forms  of  logical 
treatment,  has  a  practical  use  for  almost  every  man  of 
affairs.     In  its  higher  branches  mathematics  is  indispen- 

^A  simple  text  on  Logic,  suitable  for  the  business  man  and  the 
student  of  business,  is  Jones's  Logic,  Inductive  and  Deductive. 
(rienry  Holt  &  Co.,  New  York,  1909.) 


14  PRINCIPLES  OF  BUSINESS 

sable  to  certain  lines  of  business.  The  building  of  bridges 
and  of  tunnels,  the  installation  of  electric  systems,  the 
calculation  of  astronomical  events,  the  construction  of 
insurance  contracts,  and  the  computation  of  bond  values 
all  call  for  a  knowledge  of  higher  mathematics.  "Al- 
ready the  economic  student,  when  he  uses  the  word  mar- 
ginal instead  of  average,  or  the  merchant  when  he  speaks 
of  a  flattening  price  curve,  implies  the  application  of  the 
differential  calculus  to  economics;  and  a  few  generations 
hence  social  theorists  may  be  using,  and  newspaper  read- 
ers may  be  following,  forms  of  thought  whose  essential 
principles  are  now  understood  only  by  Professor  Bow- 
ley  and  his  mathematical  colleagues."^ 

Closely  allied  with  mathematics  is  the  science  of  sta- 
tistics, defined  by  King  in  his  Elements  of  Statistical 
Method  (p.  23)  as  "The  method  of  judging  collective 
natural  or  social  phenomena  from  the  results  obtained 
by  the  analysis  of  an  enumeration  or  collection  of  esti- 
mates." But  a  short  time  ago,  the  methods  of  statistics 
were  known  and  used  only  by  a  few  government-em- 
ployed experts.  To-day  statisticians  are  found  in  many 
business  offices.  They  advise  the  purchasing  department  in 
the  ordering  of  raw  materials,  the  production  department 
in  the  adjustment  of  labor  problems  and  the  determination 
of  output,  the  sales  department  in  the  establishment  of 
price,  and  the  treasurer's  department  on  matters  of  finan- 
cial policy.  The  execution  of  these  duties  requires  the 
services  of  a  well-trained  statistician  with  a  broad  knowl- 
edge of  economic  principles.  The  formation  recently  of 
The  American  Association  of  Financial  Statisticians 
bears  testimony  to  the  rapid  growth  of  the  use  of  statis- 
^  Graham  Wallas,  The  Great  Society,  p.  216. 


THE  ENVIRONMENT  OF  BUSINESS  15 

tics  in  a  field  that  less  than  twenty-five  years  ago  prob- 
ably did  not  regularly  employ  a  single  expert.  The 
multiplication  on  the  market  of  adding  and  other  com- 
puting devices  and  the  extended  use  of  the  Hollerith  and 
Powers  tabulating  devices  point  to  a  growing  apprecia- 
tion of  the  value  of  statistics  to  everyday  business. 

There  is  one  use  to  which  statistics  are  put  which 
deserves  special  mention.  Economists  tell  us  that  profits 
form  the  last  share  in  the  distribution  of  the  income  de- 
rived from  business.  After  wages,  rent  and  interest 
have  been  paid,  the  business  man,  or  entrepreneur,  as  he 
is -called,  gets  his  share  of  the  income  in  the  form  of 
profits.  His  share,  then,  depends  on  what  he  can  get  for 
his  product  above  the  expenses  of  production.  What 
he  gets  in  the  aggregate  is  called  the  price  of  his  product, 
and  this  depends  in  the  long  run  on  the  supply  of  and 
demand  for  the  product.  The  modern  business  man  sees 
how  important  the  price  element  is,  and  does  not  permit 
any  of  the  constituent  parts  to  be  determined  by  for- 
tuitous chance  any  more  than  is  absolutely  necessary. 
To  control  the  situation  he  resorts  to  statistics.  In  gath- 
ering these  statistics  the  government  and  private  enter- 
prises, such  as  the  daily  press  and  the  special  business 
and  financial  magazines,  come  to  his  aid.  What  the 
business  man  must  do  for  himself — and  here  is  where  a 
study  of  statistics  brings  its  reward — is  to  take  the 
statistics  thus  collected  and  interpret  them  for  his  own 
use.  First  he  must  find  out  what  he  can  about  the  sup- 
ply of  goods,  and  his  deductions  here  will  tell  him  where 
and  when  to  expand  or  contract  his  productive  opera- 
tions.    Next  he  will  search  for  the  demand.     Here  again 


i6  PRINCIPLES  OF  BUSINESS 

he  will  make  his  deductions  as  to  whether  he  ought  to 
expand  or  contract.  But  surrounding  the  whole  prob- 
lem is  the  broad  question  of  the  general  level  of  com- 
modity prices — is  it  going  up,  or  going  down?  Then 
will  come  the  question  of  the  purchasing  power  of  the 
community — and  to  answer  this  question  the  keen  busi- 
ness man  will  examine  the  so-called  barometers  which 
indicate  generally  whether  business  is  moving  toward  a 
period  of  prosperity  or  toward  a  period  of  depression. 

It  will  be  seen  that  a  study  of  business  statistics  is  of 
inestimable  value.  It  enables  a  man  to  make  proper  pro- 
visions for  changing  conditions.  It  enables  him  to  fore- 
cast what  is  going  to  happen.  "Bankers,  financiers,  and 
the  heads  of  manufacturing  and  mercantile  enterprises 
must  constantly  study  present  conditions  and  future  pros- 
pects. Many  manufacturers,  for  example,  buy  materials 
and  start  manufacturing  operations  months  before  the 
finished  goods  are  placed  upon  the  market.  Plans  must 
be  made  and  production  regulated  according  to  the 
condition's  which  such  producers  expect  to  encounter  at 
a  later  time.  If  they  err  in  judgment,  they  are  placed 
at  a  disadvantage  which  may  prove  serious.  The  malad- 
justment which  occurs  during  a  period  of  crisis  may  be 
disastious.  If  manufacturers  and  merchants  can  be 
forewarned,  fewer  will  be  caught  unawares  and  the 
severity  of  the  shocks  will  be  alleviated."'^ 

Statistics  are  also  used  in  business,  in  regulating  sales, 
in  checking  advertising  results  and  in  studying  the  oper- 

*  Copeland's  Business  Statistics,  p.  98.  Several  business  concerns 
collect,  classify,  arrange,  and  partly  interpret  business  statistics  for 
their  customers.  Tlie  Babson  service  and  those  of  Prentice  Hall  Inc., 
and  the  Standard  Statistics  Company  are  perhaps  the  best  known. 


THE  ENVIRONMENT  OF  BUSINESS         17 

ating  costs  and  results  of  factories.  Moreover,  they  are 
used  by  the  chief  executive  in  making  effective  and  effi- 
cient the  control  of  all  the  branches  of  a  business  enter- 
prise that  come  under  his  general  supervision.  In  pre- 
paring these  statistics  for  the  executive,  the  statistician 
must  choose  such  units  of  product,  service,  accomplish- 
ment or  cost  as  will  enable  the  executive  to  make  logical 
comparisons  and  to  draw  conclusions.  These  conclu- 
sions are  based  upon  comparisons  of  current  units  with 
current  units  of  other  plants  or  enterprises  or  with  the 
past  performance  of  the  same  business.^ 

Physics  and  chemistry. — Perhaps  most  people  think 
of  physics  and  chemistry — the  sciences  of  the  molecule 
and  of  the  atom — when  the  word  "science"  is  mentioned. 
Certainly  these  two  sciences  have  made  the  most  spec- 
tacular strides  in  the  last  generation  and  there  seems  to 
be  a  complete  alliance  between  them  and  business.  One 
has  but  to  mention  electricity,  gas  engines,  moving  pic- 
tures, the  submarine,  flying-machines  and  X-rays  to 
bring  vividly  to  mind  the  progress  of  physics  and  the  debt 
which  business  owes  it.  From  the  dawn  of  history  until 
only  about  150  years  ago — that  is,  through  an  age  of 
about  10,000  years — less  progress  was  made  in  locomo- 
tion than  in  the  150  years  just  past.  And  when  we  con- 
sider that  every  single  phase  and  function  of  business 
may  be  reduced  to  a  matter  of  motion,  we  can  realize 

^The  growing  importance  of  statistical  investigations  in  all 
branches  of  business  warrants  the  somewhat  extended  statement 
of  the  relation  of  statistics  to  the  science  of  business  given  above. 
The  student  who  would  understand  more  about  the  problems  which 
statistics  undertakes  to  solve  for  the  business-  man  and  about  the 
way  it  proceeds  to  solve  them  is  referred  to  the  various  essays 
reproduced  in  Copeland's  book  of  readings  entitled  Business  Sta- 
tistics.    (Harvard  University  Press,   1917.) 


1 8  PRINCIPLES  OF  BUSINESS 

how  deep  is  the  debt  of  modern  business  to  modern  physi- 
cal science. 

The  problems  which  business  brings  to  chemistry  are 
legion.  A  large  part  of  the  industry  of  America  was 
disorganized  at  the  outbreak  of  the  European  war  be- 
cause our  chemists  had  not  learned  how  to  make  dyes. 
Then  for  the  first  time  many  people  recognized  the  par- 
ticular everyday  utility  of  expert  chemical  training.  But 
for  years  the  chemist  in  his  laboratory  had  been  work- 
ing on  the  problems  of  the  business  man.  To  his  efforts 
in  part  was  due  Germany's  unexpected  war  endurance. 
German  chemists  turned  industry  upside  down  to  supply 
the  wants  of  a  people  that  had  imported  $2,500,000,000 
worth  of  goods  a  year  and  then  had  been  cut  off  from 
most  of  the  civilized  world.  Making  clothes  of  paper 
and  making  feed  of  sawdust,  yeast  and  gas-house  refuse 
were  inventions  born  of  necessity  that  the  German  chem- 
ists presented  to  industry  while  it  attempted  to  keep  up 
with  the  demands  of  a  besieged  population. 

In  America,  for  many  years,  chemists  have  been  at  their 
wits'  end  to  meet  the  demands  of  the  business  man. 
Here  is  a  partial  list  of  business  inquiries  that  were 
brought  to  one  of  them  :  "The  dentists  are  desperately 
in  need  of  a  cement  that  is  'absolutely'  insoluble  in  the 
mouth;  manufacturers  of  toilet  preparations  need  a 
method  of  compressing  powdered  pumice,  for  mixing  it 
with  Portland  cement  is  not  satisfactory.  The  glass- 
makers  are  eagerly  desirous  of  a  method  of  manufactur- 
ing a  ruby  glass  in  the  pots,  for,  as  it  is  and  always  has 
been,  the  ruby  color  of  the  glass  flashes  out  on  one  or 
more    reheatings — an    expensive    operation.      A   certain 


THE  ENVIRONMENT  OF  BUSINESS         19 

enormous  manufactory  of  artificial  cereals  in  packages 
is  seriously  concerned  with  the  damage  to  these  same 
packages  by  rats,  and  it  desires,  if  possible,  some 
method  of  making  these  packages  distasteful  to  rats  with- 
out conflicting  with  the  pure-food  laws.  Another,  equally 
huge  in  the  extent  of  its  manufacture  and  its  operations, 
is  embarrassed  through  the  curious  fact  that  while  grass- 
hoppers will  have  nothing  to  do  with  binder-twine  made 
of  imported  flax,  they  avidly  devour  the  domestic  prod- 
uct, and  with  a  consequent  loss  of  a  million  a  year  to 
the  company  concerned,  to  say  nothing  of  its  loss  of  repu- 
tation among  the  farmers."^  It  is  well  for  the  American 
business  man  to  know  generally  that  in  his  midst  are 
men  who  are  not  content  with  things  as  they  are,  but 
who  draw  upon  expert  scientific  knowledge  and  train- 
ing to  prevent  waste  and  to  promote  production  and  effi- 
ciency. "Chemistry,"  says  the  Twelfth  Census  Report, 
"is  the  intelligence  department  of  business." 

Other  natural  sciences. — While  astronomy  is  perhaps 
the  oldest  science,  it  also  contributes  the  least  to  modern 
business.  Our  knowledge  of  the  heavens  does  mean  a 
lot  to  business.  Time  is  accurately  calculated  and  navi- 
gation is  made  possible  through  the  process  of  finding  the 
longitude  and  latitude  and  through  the  process  of  de- 
termining the  error  of  the  compass.  But  little  progress 
is  being  made  in  the  science  that  is  of  practical  importance 
to  the  business  man,  nor  does  the  science  enter  in  any 
large  degree  into  the  business  life  of  today. 

Geology  and  its  closely  associated  science,  mineralogy, 

^Robert  Kennedy  Duncan's  Some  Chemical  Problems  of  Todayf 
pp.  14-15. 


20  PRINCIPLES  OF  BUSINESS 

do  everyday  duty  for  the  business  man.  The  United 
States  government  spends  nearly  half-a-million  a  year 
in  making  geological  investigations  and  publishing  the 
results,  and  perhaps  the  separate  states  of  the  Union 
spend  an  equal  sum.  Sources  of  mineral  supply  are  thus 
discovered,  and  capitalists  are  given  some  authoritative 
data  upon  which  to  base  their  judgment  when  consider- 
ing applications  from  promoters  for  funds  with  which 
to  exploit  the  mineral  resources  of  a  given  region. 

Biology  is  the  science  of  living  matter.  It  has  made 
wonderful  progress  in  the  last  quarter-century.  Bac- 
teriology, for  example,  a  branch  of  biology,  has  aided 
business  not  only  in  preservation  of  life  and  health,  both 
of  which  are  considerations  of  the  utmost  importance  in 
the  production  process^  but  in  the  production  of  many 
useful  commodities  through  the  use  of  bacteriological 
agencies. 

In  passing,  we  ought  to  give  credit  to  biology  for  its 
enunciation  of  the  principle  of  the  survival  of  the  fit- 
test. The  pure  theorist  in  business  and  economics  can- 
not afford  to  overlook  this  principle  in  the  study  of  such 
questions  as  monopoly  and  competition,  wages,  and  the 
like. 

Summary. — The  importance  of  the  sciences  thus  far 
studied  is  confined  quite  closely  to  the  general  field  of  pro- 
duction. When  one  thinks  of  business,  one  usually  does 
not  give  production  a  conspicuous  place  in  the  mental  pic- 

1  The  regulation  of  the  dairy  industry  is  an  example.  Bacteria 
counts  in  milk-samples  not  only  practically  determine  the  grade 
and  consequently  the  selling  price,  but  high  counts  force  low-grade 
dairies  out  of  business  or  compel  the  owners  to  remodel  their 
barns  and  equipment  as  well  as  to  improve  their  methods  of  op- 
eration. 


THE  ENVIRONMENT  OF  BUSINESS         21 

ture.  Business  is  generally  conceived  as  related  to  the 
processes  of  distribution  rather  than  to  those  of  produc- 
tion. Thus  we  say  that  the  business  man  is  not  the  factory 
manager  or  works  superintendent,  but  the  man  who  sits 
in  the  office  and  directs  the  marketing  and  the  financing. 
In  other  words  the  business  man  does  not  study  the  rela- 
tion of  his  business  entity  to  the  production  processes 
as  much  as  its  relation  to  the  outside  world.  The  fact 
is  that  there  is  a  constant  tendency  to  commit  the  prob- 
lems of  production  to  salaried  men  of  experience  and 
expert  technical  training,  and  to  hold  them  responsible 
for  general  results.  The  broader  questions  of  policy 
involved  in  the  relation  of  the  business  and  its  product 
to  the  outside  world  are  reserved  to  the  entrepreneur 
himself — to  the  business  man.  The  problems  arising  are 
considered  business  problems. 

BIBLIOGRAPHY 

Columbia  Wnhnsify,  Lectures  on  Science,  Philosophy  and  Art. 

Copeland,  Business  Statistics,  Chapter   I. 

Secrist,   Horace,   An  Introduction   to  Statistical   Methods. 

Kip.g,   W.   I.,   Elements  of  Statistical  Methods. 

Lucke,  Charles  E.,  Power. 

Duncan,   Robert   Kennedy,  Some   Chemical  Problems  of    Today. 

Sn3'der,  Carl,  Ah^zc  Conceptions  in  Science. 

Secrist,    Horace,    Statistics   in    Business. 

Haskel,  Allen  C,  Hozv  to  Make  and  Use  Graphic  Charts. 


CHAPTER  III 

THE  SOCIAL  SCIENCES 

The  place  of  the  social  sciences  in  the  science  of 
business. — It  is  for  the  reason  touched  upon  at  the  close 
of  the  preceding-  chapter  that  the  sciences  designated  as 
social  sciences  have  been  so  heavily  drawn  upon  by 
teachers  and  students  of  business  science.  The  social 
sciences,  indeed,  are  generally  regarded  as  the  base  upon 
w^hich  the  business  student  must  rear  his  specialized 
knowledge  of  the  science  of  business  per  se.  Perhaps  the 
diagram  given  below,  though  open  to  criticism  as  being 
too  rigid,  and  misleading  somewhat  in  some  of  the  rela- 
tions it  indicates,  approximates  the  structure  of  the 
science  of  business  and  its  environment. 


Production                        | 

Marketing 

Accounting                     and 

Financing 

Natural  and  Physical  Sciences      | 

Social  Sciences 

Logic                                      Mathematics 

Statistics 

Because  of  the  more  intimate  relation  of  the  social 
sciences  to  the  problems  generally  considered  to  be  pe- 
culiarly of  a  business  nature,  we  shall  have  to  devote 
more  space  to  them  than  we  have  devoted  to  the  natural 
sciences. 

What  are  the  social  sciences? — It  is  unnecessary  for 

22 


THE    SOCIAL    SCIENCES  -     23 

us  here  to  go  into  any  lengthy  discussion  of  the  place  of 
the  social  sciences  to  analyze  them  into  the  many  branches 
that  have  been  evolved  from  the  specialized  studies  of 
writers  and  teachers.  We  shall  briefly  take  up  history, 
sociology,  economics,  politics,  jurisprudence,  ethics  and 
psycholog}^  and  show  to  what  extent  they  may  contribute 
to  the  training  of  the  well-informed  business  man.  In  a 
general  way,  all  of  these  sciences  deal  with  man  in  his 
relation  to  his  environment  and  to  his  fellow  men,  and 
are  therefore  properly  called  social  sciences. 

The  shortcomings  of  the  social  sciences. — Some 
people  doubt  whether  there  can  be  any  social  sciences. 
Organic  society  is  so  changeable,  so  the  argument  runs, 
that  generalizations  are  well-nigh  worthless.  It  must 
be  admitted  that  general  laws  deduced  from  collections 
of  social  phenomena  may  be  so  far  from  the  truth  when 
applied  to  an  individual  case  that  they  may  lead  to 
ridiculous  results.  I  have  known  some  men  with  weak 
chins  who  have  had  strong  wills.  The  fact  is  that  social 
science  cannot  give  positive  laws  but  depends  largely 
on  averages.  From  these  averages  we  can  expect  to 
find  little  deviation  in  individual  cases,  but  on  the  other 
hand,  the  average  may  not  exactly  represent  any  sin- 
gle individual  of  the  number  that  entered  the  sum  from 
which  the  average  was  derived.  This  whole  subject 
is  so  important,  not  only  to  the  business  man  but  also 
to  the  professed  scientist,  that  we  shall  take  the  space 
to  explain,  in  the  words  of  another,  just  what  claims 
the  social  science  can  and  should  make  as  a  means  for 
providing  not  only  an  interpretation  of  human  conduct 
but  for  guidance  as  well.     In  thus  marking  off  clearly 


24  PRINCIPLES  OF  BUSINESS 

the  limits  beyond  which  the  social  sciences  cannot  go,  we 
shall  anticipate  the  complaint  of  "the  practical  man," 
who  insists  that  science  is  useless  in  business  because 
sociology  and  economics  will  not  do  as  much  for  han- 
dling a  road-gang  as  "horse  sense"  or  Irish  wit. 

The  services  of  social  sciences  to  human  arts. — 
The  quotation  referred  to  in  the  previous  paragraph 
is  from  J.  A.  Hobson's  Work  and  Wealth,  A  Human 
Valuation  (pp.  340-347),  and  is  as  follows: 

"Science  takes  its  stand  upon  a  twofold  application 
of  the  assumption  of  the  uniformity  of  Nature,  first, 
that  all  differences  of  composition  can  be  treated  as 
differences  of  quantity  or  degree,  secondly,  that  history 
repeats  itself.  Now,  just  so  far  as  these  assumptions 
fit  the  facts,  Science  is  valid  for  interpretation  and  for 
guidance.  This  explains  why  astronomy,  physics  and 
chemistry  are  more  'exact'  sciences  than  biology  or  psy- 
chology, and  why  they  are  able  to  give  more  reliable  and 
authoritative  rules  for  the  arts  of  navigation,  engineer- 
ing and  drug-making,  than  the  latter  can  for  medicine, 
for  breeding  or  for  education.  *  *  *  In  all  arts  dealing 
entirely  or  mainly  with  inorganic  matter  science  occu- 
pies a  seat  of  high  authority,  because  of  the  high  rela- 
tive uniformity  of  this  matter  and  the  comparative  regu- 
larity of  its  behavior.  In  physics  or  in  inorganic  chem- 
istry the  individual  differences  or  eccentricities  of  the 
material  are  so  trivial  that  they  can  usually  be  disre- 
garded, and  history  repeats  itself  with  so  much  regu- 
larity that  quantitative  laws  apply. 

"The  passage  from  the  inorganic  to  the  organic  in- 
volves, as  we  recognize,  a  double  assertion  of  the  quali- 


THE   SOCIAL    SCIENCES  25 

tative :  first,  in  respect  of  the  unity  and  uniqueness  of 
the  organic  structure,  and  secondly,  by  reason  of  the 
novelty  that  attends  each  act  of  organic  change,  vital 
movement,  assimilation,  growth,  reproduction  or  decay. 
The  uniqueness  of  the  individual  organism  and  the  nov- 
elty of  each  of  its  changes  are  an  assertion  of  the  quali- 
tative nature  of  the  subject-matter.  So  far  as  this  quali- 
tative nature  prevails  and  counts  for  'conduct,'  scientific 
analysis  is  impotent  for  interpretation  and  advice.  When 
organic  matter  attains  the  character  or  consciousness  and 
the  still  higher  character  of  self-consciousness,  the  quali- 
tative considerations  reach  a  maximum,  and  the  inter- 
pretation and  directive  power  of  science  a  minimum. 
But  that  minimum  must  not  be  disparaged.  It  is  not 
inconsiderable.  The  assistance  which  scientific  laws  can 
render  to  the  finest  arts  of  human  conduct  is  very  impor- 
tant and  is  capable  of  constant  augmentation.  For  so 
far  as  human  nature  is  uniform  and  stable  among  the 
units  which  constitute  the  life  whose  conduct  and  wel- 
fare are  in  question,  the  interpretation  and  direction  of 
science  has  validity.  To  this  extent,  a  utilitarian  cal- 
culus, based  upon  analysis  of  past  experience,  can  aid 
the  statesman  or  the  philanthropist  in  working  out  his 
design.  In  the  region  of  industry  the  extent  of  this  scien- 
tific service  will  be  even  greater  than  in  the  arts  of  con- 
duct whose  material  is  more  exclusively  organic  or  physi- 
cal. For  industry,  considered  as  an  art  of  human  wel- 
fare, will  consist  largely  in  the  orderly  and  progressive 
adaptation  of  inorganic  matter,  or  of  organic  matter 
whose  organic  differences  can  be  ignored,  to  the  satis- 
faction of  those  needs  of  mankind  in  which  men  are 


26  PRINCIPLES  OF  BUSINESS 

similar.  That  is  to  say,  in  industry  there  exists  and 
will  remain  a  great  deal  of  work  and  of  consumption 
which  is  essentially  of  a  uniform  or  routine  character, 
requiring  to  be  done  by  measured  rules,  and  depending 
for  its  utility  upon  the  exclusion  of  all  individuality  or 
quality.  This  applies,  not  only  to  those  industrial  proc- 
esses which  we  term  strictly  mechanical,  but  to  a  great 
many  others  where  quality  is  a  matter  of  comparative 
indifference.  In  the  progressive  economy  of  human  wel- 
fare mechanical  or  routine  production  will  even  fre- 
quently displace  an  art  in  which  quality  was  once  dis- 
played. So  home-baking,  into  which  no  small  degree  of 
culinary  skill  could  go,  has  given  way  to  machine-baking, 
in  which  the  element  of  personal  skill  plays  a  diminished 
part,  and  on  which  the  individual  taste  of  the  consumer 
exerts  little  directive  influence.  This  may  be  taken  as  a 
typical  example  of  the  displacement  of  qualitative  art 
by  quantitative  mechanism.  It  is,  of  course,  of  very 
wide  extension,  being,  in  fact,  commensurate  with  the 
application  of  scientific  methods  in  the  world  of  indus- 
try. Indeed,  the  sciences  of  chemistry  and  physics,  bot- 
any and  biology,  are  everywhere  invading  the  'arts'  of 
industry  and  imposing  'rules'  upon  industrial  processes. 
Even  more  significant  is  the  application  of  the  still  in- 
fantile science  of  psychology  to  the  arts  of  business  or- 
ganization and  enterprise  and  of  marketing.  How  can 
psychology  assist  in  the  delicate  art  of  recommending 
goods  to  possible  purchasers?  Only  on  the  supposition 
that  there  is  sufficient  uniformity  and  stability  in  human 
nature  to  enable  the  measured  rules  of  past  experiment 
upon  other  men  to  hold  of  this  man.    Only  so  far  as  men 


THE    SOCIAL    SCIENCES  27 

are  really  the  same  sort  of  stuff,  or  so  far  as  any  differ- 
ences are  measurable  and  calculable.  Novelty  alone 
can  baffle  applied  science. 

"If  it  were  true,  as  some  appear  to  think,  that  ma- 
chinery and  routine  method  were  destined  continually 
to  absorb  a  larger  and  larger  proportion  of  human  work, 
and  to  direct  a  larger  and  larger  share  of  human  life, 
economic  science  with  its  quantitative  calculus  would  ac- 
quire a  continual  increase  of  exactitude  and  a  growing 
capacity  for  direction  in  the  art  of  social  conduct.  But 
if,  as  seems  more  reasonable,  progressive  industry  must 
serve  to  feed  a  richer  liberty  and  novelty  of  individual 
and  social  life,  the  domain  of  quantitative  calculus, 
though  absolutely  enlarging,  may  be  relatively  shrinking. 

"We  now  seem  able  to  get  a  more  accurate  under- 
standing of  what  a  scientific  calculus  can  do  for  the 
assistance  of  the  art  of  social  welfare.  It  can  do  for 
that  art  what  it  can  do  for  every  other  art,  viz.,  furnish 
rules  for  the  regular.  So  far  as  the  stuff  which  consti- 
tutes or  composes  human  welfare  is  uniform,  i.e.,  so 
far  as  men  are  alike  in  their  needs,  and  the  material  for 
the  satisfaction  of  these  needs  is  similar,  it  can  supply 
rules  of  social  economy  which  will  have  a  high  degree  of 
validity.  Though  no  two  human  organisms  are  identi- 
cal in  structure,  all  human  organisms  within  a  wide 
range  of  environment  are  so  similar  in  the  kinds  of  food, 
air  and  other  material  goods  which  they  require,  that  it 
is  sound  'social  policy'  to  ignore  their  differences  and 
to  treat  them  as  identical  in  the  qualities  of  their  demands 
and  dissimilar  only  in  the  quantities.  The  practical 
economy  of  'markets'   stands  upon  this  basis,   and  the 


28  PRINCIPLES  OF  BUSINESS 

quantitative  treatment  finds  its  true  justification  in  the 
utility  of  markets.  There  can  be  no  market  for  the 
single  or  'singular'  consumer.  A  market,  i.e.,  a  prac- 
tical instrument  for  measurement  of  economic  wants,  im- 
plies a  standardization  of  the  desires  of  buyers  and  sell- 
ers. Just  so  far  as  the  members  of  an  economic  com- 
munity are  thus  standardized  in  their  preferences,  are 
economic  laws  applicable.  Thus,  for  the  scientific  inter- 
pretation of  such  a  community,  much  depends  upon  the 
relative  strength  and  importance  of  the  standardizing 
and  the  individualizing  forces.  In  a  society  where  the 
so-called  'arts'  of  industry  and  of  consumption  have  alike 
passed  by  imitation  or  tradition  into  firm  conventions 
from  which  the  least  transgression  is  branded  as  an  im- 
piety or  a  wickedness,  economic  laws,  based  upon  a  suf- 
ficient study  of  the  past  and  present,  will  enable  one  to 
predict  the  future  with  considerable  accuracy.  Primi- 
tive or  backward  communities  are  usually  in  this  con- 
servative condition.  Moreover,  as  they  advance  and  be- 
come economically  progressive,  it  is  observable  that  the 
most  conservative  and  most  calculable  wants  and  activi- 
ties are  those  relating  to  the  satisfaction  of  the  primary 
material  needs.  Hence  it  is  evident  that  scientific  pre- 
dictions, based  either  upon  general  considerations  of 
human  nature  or  upon  past  measurements,  will  come 
nearest  to  fulfilment,  according  as  they  relate  to  the  pro- 
duction and  consumption  of  those  articles  most  deeply 
embedded  in  the  standard  of  living.  Conveniences  and 
comforts  are  more  changeable  than  necessaries,  and  lux- 
uries most  changeable  of  all.  Now  the  marginal  or  least 
useful  portion  of  those  supplies,  which  in  the  earlier  or 


THE   SOCIAL   SCIENCES  29 

most  useful  increments  satisfy  some  prime  need,  are  often 
luxuries.  The  marginal  portion  of  the  wheat  supply 
goes  for  cakes,  or  is  thrown  into  the  dust-bin  as  waste 
bread;  the  marginal  oil  goes  into  motor  rides.  Taking 
expenditure  in  general,  we  find  the  last  ten  per  cent  of 
every  income  most  incalculable  in  its  outlay,  because  it 
represents  those  purchases  in  which  custom  is  weakest 
and  individual  taste  or  opportunity  tkt  strongest.  In  a 
word,  it  is  precisely  in  those  economic  actions  which 
express  marginal  preferences,  the  pivot  of  the  mechanical 
calculus,  that  we  find  the  maximum  of  instability  and 
incalculability.  For  each  of  these  nice  marginal  prefer- 
ences proceeds  directly  from  the  changing  nature  of  the 
organic  personality.  Whereas  fifty  per  cent  of  a  man's 
expenditure  may  express  the  common  satisfaction  of  the 
fixed  physical  needs  which  custom  has  embedded  in  a 
standard  of  subsistence,  thirty  per  cent  the  lighter  but 
fairly  stable  comforts  belonging  to  his  class,  the  last 
twenty  per  cent  is  the  part  in  which  he  expresses  his 
individual  character  and  his  cravings  for  personal  dis- 
tinction and  variety  of  enjoyment.  *  *  * 

"Neither  as  a  deductive  nor  as  an  inductive  science 
can  Economics  furnish  accurate  rules  for  calculating  or 
directing  future  economic  events.  It  can  only  prophesy 
within  such  limits  as  are  set  by  the  assumptions  of  the 
stability  of  human  nature  and  of  its  environment.  Its 
rules  or  'laws'  will  best  interpret  and  predict  those  eco- 
nomic actions  which  are  most  remote  from  the  margin, 
i.e.,  those  which  are  most  conservative  or  regular.  Mar- 
ginal preferences  will  therefore  be  precisely  those  which 
it  is  precluded   from  interpreting  or  predicting  by  the 


30  PRINCIPLES  OF  BUSINESS 

necessary  defect  of  the  intellectual  instrument.  *  *  * 

"Economic  science,  though  able  to  supply  relevant  and 
important  evidence,  can  never  solve  conclusively  any 
social-economic  problem,  even  in  that  field  of  action 
where  her  authority  is  most  strongly  asserted.  A  given 
rise  or  fall  of  price  can  never  produce  the  same  effect 
upon  demand  twice  running.  Why?  Because  the  de- 
sires and  beliefs  of  the  more  unsettled  section  of  buy- 
ers, the  'marginal'  buyers,  will  have  changed.  Nor  can 
this  alteration  in  effect  upon  demand  be  calculated.  Why 
not?  Because  the  changes  in  desires  and  beliefs  are  or- 
ganic qualitative  changes.  Observations  of  past  price- 
movements  and  laws  based  upon  them  are  not  thereby 
rendered  useless.  For  these  organic  changes  will  often 
be  negligible  so  far  as  the  bulk  of  the  market  is  con- 
cerned. But  they  negate  the  possibilities  of  exact  pre- 
diction, and  often  of  approximate  predictions  on  the 
margin. 

"This  is  why  the  'great'  business  man  often  prefers 
to  act  by  intuition  than  by  express  calculation.  He  recog- 
nizes that,  so  far  as  the  more  delicate  judgments  are 
concerned,  his  'feeling'  of  'how  things  will  go'  is  more 
trustworthy  than  any  estimate.  He  does  not  act  blindly. 
He  feeds  and  fortifies  his  mind  with  facts  and  figures, 
until  he  is  steeped  in  familiarity  with  the  subject-mat- 
ter. But  he  does  not  deliberately  balance  against  one 
another  these  measured  forces  and  commit  himself  to 
the  resultant.  For  he  is  aware  that  the  problem  is  not 
one  of  mere  mechanics,  a  counting-house  proposition, 
but  one  involving  sympathy  and  imagination. 

"The  incalculable  element  consists  of  organic  novelty, 


THE    SOCIAL    SCIENCES  31 

the  changes  due  to  having  to  deal  with  matter  not  dead 
and  homogeneous  but  living  and  organized.  The  cita- 
tion of  such  instances  is  not  designed  to  prove  that  mone- 
tary and  other  statistics  are  practically  useless  for  the 
prediction  and  solution  of  social-economic  problems.  On 
the  contrary,  they  are  exceedingly  useful.  But  the  for- 
mal exactitude  which  they  carry  in  their  method  can 
never  be  conveyed  into  the  work  they  are  required  to 
assist  in  doing.  The  most  abundant  supply  of  the  most 
accurate  statistics,  utilized  by  the  most  approved 
methods  of  economic  science,  can  only  afford  results  of 
a  rude  approximate  validity,  expressed  in  tendencies. 
The  practical  man  in  business,  in  politics,  in  every  mode 
of  social  conduct,  will  supplement  and  correct  the  appli- 
cation of  the  scientific  rule  by  the  play  of  private  judg- 
ment and  intuition."^ 

History. — Men  of  the  generation  whose  work  is  just 
about  drawing  to  a  close  will  tell  you  that  when  they 
studied  history,  they  read  about  military  and  political 
affairs — about  the  exploits  of  Greek  and  Roman  warriors 
and  the  intrigues  of  kings  and  statesmen.  The  middle 
ages  included  some  account  of  the  progress  of  religious 
thought,  but  in  the  modern  periods  history  again  relapsed 
into  an  account  of  military  and  political  events.  But  his- 
tory has  an  economic  side  which  is  of  vastly  more  impor- 
tance to  the  modern  man  of  affairs.  Military  events  are 
likely  to  be  the  consequences  of  political  changes  and  of 
political  strain  and  stress,  and  political  changes  and  cur- 
rents are  likely  to  be  caused  and  ordered  by  economic 

^For  a  further  discussion  of  this  subject,  see  Appendices  C  and  D 
of  Marshall's  Principles  of  Economics. 


32  PRINCIPLES  OF  BUSINESS 

evolution.  A  study  of  the  economic  self-sufficiency  of 
Egypt  will  explain  more  of  her  peculiar  history  than 
will  that  of  any  account,  however  circumstantial,  of  the 
ambitions  and  doings  of  her  kings  and  potentates.  One 
cannot  understand  the  American  and  French  Revolu- 
tions unless  one  realizes  the  economic  changes  brought 
into  the  world  by  the  steam  engine  and  the  printing  press. 

History  for  the  business  man  should  chiefly  be  con- 
cerned with  the  answer  to  the  question.  How  has  the 
swarm  of  humanity  reacted  to  given  economic  changes? 
To  answer  this  question  he  must  study  political  events 
with  a  critical  mind  to  find  behind  them  the  economic 
and  sociological  causes.  Fortunately,  the  historian,  in 
these  latter  days,  has  made  the  task  comparatively  easy 
by  supplying  historical  studies  which  make  the  proper 
economic  and  sociological  inquiries.^ 

The  advantages  of  historical  study  to  the  business  man 
may  be  illustrated  as  follows.  In  the  summer  of  19 17, 
the  American  Government  fixed  the  price  of  steel,  cop- 
per, wheat  and  several  other  necessaries.  It  was  found 
that  speculators  were  beginning  to  corner  the  necessary 
commodities,  and  the  question  was  submitted  through 
various  trade  associations  whether  the  Government 
should  be  urged  to  increase  the  number  of  articles  on 
which  it  would  fix  prices.  I  happened  to  hear  the  dis- 
cussion of  this  question  in  several  meetings.  Some  were 
for  price-fixing  and  others  against  it.  Undoubtedly  in 
each  case,  self-interest  was  the  most  important  factor 
that  led  to  an  opinion  one  way  or  the  other.    But  on  the 

1  The  serious  student  may  begin  with  Biicher's  Industrial  Evolu- 
tion and  then  read  economic  histories,  so-called,  of  Europe,  England, 
and  America. 


THE    SOCIAL    SCIENCES  33 

whole  it  seemed  that  the  business  men  were  somewhat 
panic-stricken  at  the  outlook.  Something  had  to  be  done. 
Just  what  ought  to  be  done,  nobody  seemed  to  be  pre- 
pared to  say.  In  other  words,  there  was  no  such  cock- 
sureness  evident  as  generally  characterizes  politico-eco- 
nomic discussions.  Perhaps  the  Government  knew  what 
w^as  best.  If  they  could  fix  the  price  of  a  few  things 
they  could  fix  the  price  of  the  rest.  That  seemed  to  be 
a  general  feeling  amongst  the  anxious  business  men. 
The  argimient,  of  course,  appears  to  be  faulty  to  the 
scientific  mind,  for  the  difficulty  in  fixing  prices  really 
arises  when  the  interactions  of  a  complex  business  struc- 
ture are  artificially  interfered  with.  One  or  two  rela- 
tionships may  be  brought  under  control,  but  each  new 
element  brought  into  the  situation  complicates  it  many, 
many  times  over. 

But  the  question  need  not  be  settled  wholly  by  a  priori 
reasoning.  History  furnishes  a  precedent.  The  price- 
fixing  of  the  fifteenth  century,  to  be  sure,  was  not  ex- 
actly similar  to  that  proposed  by  the  Government  at 
Washington,  but  it  may  throw  some  light  on  the  situa- 
tion. Economists  generally  believe  that  it  was  not  very 
successful  as  practised  in  the  Middle  Ages.  (See  Ash- 
ley's Economic  History,  Middle  Ages,  p.  187  et  seq.  and 
Part  II,  p.  30  et  seq.) 

On  the  other  hand,  the  Hmitations  on  the  value  of 
historical  study  are  also  evident  in  tliis  illustration.  Be- 
cause they  could  not  successfully  fix  prices  five  centuries 
ago  is  no  conclusive  reason  why  it  cannot  be  done  now. 
Rapidity  of  communication  alone  might  make  it  feasible. 
As  one  author  points  out,  they  tried  flying  in  the  fifteenth 


34  PRINCIPLES  OF  BUSINESS 

century  and  failed.     But  that  was  no  reason  why  at- 
tempts at  flying  in  the  twentieth  century  should  fail. 

It  is  perhaps  unfortunate  for  economic  history  as  a 
science  that  its  originator  was  Karl  Marx,  the  "father" 
of  modern  socialism.  Some  students  have  rejected 
economic  history  as  a  science  that  can  explain  anything 
or  can  have  any  laws  because  Marx  and  other  socialists 
used  it  to  bulwark  their  socialistic  theories.  But  Profes- 
sor Seligman  in  his  The  Economic  Interpretation  of  His- 
tory has  shown  how  unwise  it  is  to  condemn  the  science 
for  the  unwarranted  use  to  which  it  was  put  by  its  orig- 
inator. 

What  are  the  respective  fields  of  economics,  so- 
ciology and  ethics? — The  three  social  sciences — eco 
nomics,  sociology  and  ethics — lie  so  close  to  one  another 
that  trouble  is  sometimes  encountered  in  drawing  the 
line  where  one  ends  and  the  other  begins.  Economics 
seeks  to  study  the  ways  and  means  whereby  man  adjusts 
himself  to  his  environment  in  nature  and  to  overcome 
the  burden  that  nature  lays  on  man  in  his  struggle  for 
existence.  Sociology  studies  the  struggle  of  man  in  his 
environment  among  men.  What  physiology  and  psychol- 
ogy do  for  the  individual,  sociology  does  for  the  group. 
Ethics  deals  with  the  struggle  of  man  within  himself  to 
avoid  doing  what  is  by  custom  considered  wrong. 

Ethics. — We  may  begin  with  the  study  of  ethics,  since 
as  it  has  been  developed  largely  by  philosophers  and 
theologians  through  abstract  reasoning  and  without  much 
reference  to  the  facts  of  everyday  life,  it  does  not  con- 
tribute as  much  to  the  science  of  business  as  do  economics 
or  sociology. 


THE    SOCIAL    SCIENCES  35 

A  recent  writer  has  summed  up  the  field  of  business 
ethics  as  follows :  "What  are  the  moral  obligations,  the 
duties  of  the  business  man?  Is  it  enough  that  he  be 
honest  and  square  in  all  his  dealings?  His  reputation 
as  an  honest  dealer,  as  a  man  who  has  never  cheated  a 
customer  nor  violated  the  law,  is  a  valuable  busmess 
asset.  Has  he,  having  earned  his  reputation,  performed 
all  his  duties  as  a  business  man  ? 

"Business  is  a  co-operative  matter.  Nothing  much 
can  be  accomplished  in  it  unless  men  work  together  for  a 
common  result.  Now,  men  cannot  be  closely  associated, 
working  side  by  side,  some  subordinate  to  others,  without 
that  clashing  of  self-interest  which  gives  rise  to  moral  or 
ethical  problems.  It  is  evident  that  honesty  cannot  be 
regarded  as  the  sole  necessary  virtue  in  business.  Duty 
demands  much  more  of  a  business  man. 

"Responsibility  and  duty  are  usually  commensurate 
with  power  and  authority,  hence  the  head  of  a  large  busi- 
ness with  many  employees  subject  to  his  will  carries  upon 
his  shoulders  serious  duties  as  well  as  responsibilities. 
He  may  ignore  the  moral  imperative  or  command,  but  no 
civilized  conscience  will  accept  the  excuse  of  Cain  that 
he  is  not  'his  brother's  keeper.' 

"Economics  teaches  that  in  general  the  rate  of  wages 
is  fixed  by  the  law  of  demand  and  supply.  When  an  em- 
ployee thinks  that  his  particular  wage  'ought'  to  be 
raised,  has  the  employer  done  his  full  duty  by  that  em- 
ployee when  he  quotes  to  him  the  law  of  demand  and 
supply?  Or  should  he  make  clear  to  the  employees 
just  why  he  is  not  worth  more  and  what  he  must  do  to 
make  his  services  more  valuable? 


36  PRINCIPLES  OF  BUSINESS 

"The  laws  of  political  economy  are  based  on  conditions 
as  they  exist,  not  on  conditions  that  ought  to  be. 

"This  fact  the  enlightened  business  men  of  to-day  are 
beginning  to  understand,  and  they  are  recognizing  it  as 
their  duty  to  improve  the  conditions  under  which  men 
work.  The  relations  of  employer  to  employee  are  more 
than  economic.  They  are  personal  and  ethical.  The 
business  man  who  thinks  of  his  men  as  so  many  tools  or 
machines  to  be  worked  to  the  utmost  and  then  scrapped, 
is  a  shameless  violator  of  the  moral  law.  It  is  the  duty 
of  the  employer  to  see  that  his  men  shall  work  under  the 
best  possible  conditions,  that  their  souls  shall  be  properly 
replenished  by  variety  of  employment  and  by  recreation, 
and  that  they  shall  have  opportunity  for  mental  growth. 

"There  is  a  sense  in  which  it  is  absolutely  true  that  an 
employer  is  the  'keeper  of  his  employee.'  The  business 
man  who  denies  it  is  ethically  unsound. 

"The  man  who  does  not  co-operate  with  his  competi- 
tors in  their  effort  to  raise  standards,  enforce  laws  and 
prevent  unfair  practices,  is  ethically  recreant.  A  hun- 
dred years  ago  such  co-operation  was  not  practical,  but 
today  the  means  of  rapid  communications  and  publicity 
make  possible  what  may  be  called  solidarity  or  unity  in 
any  line  of  business  or  trade.  That  accounts  for  the 
great  increase  in  the  number  of  business  associations  dur- 
ing recent  years,  such  as  the  National  Credit  Men's  Asso- 
ciation, the  American  Association  of  Public  Accountants, 
the  American  Bankers'  Association.  One  of  the  objects 
of  these  associations  is  the  establishment  and  mainte- 
nance of  codes  of  ethics  or  honor.  A  business  man  who 
neglects  to  support  the  association  that  has  been  organ- 


THE    SOCIAL    SCIENCES  37 

ized  for  the  good  of  his  line  of  business  neglects  a  real 
duty."^ 
^Johnson,  Business  and  the  Man,  pp.  112  et  seq. 

BIBLIOGRAPHY 

Biicher,  Social  Evolution. 

Hobson,  J.  A.,  Work  and  IVcalih. 

Hobson,  J.  A.,   The  Evolution   of  Modern  Capitalism. 

Seligman,  Edwin  R.  A.,   The  Economic  Interpretation  of  History. 

Deale:^,  James   Quayle,   Sociology. 

Columbia    University,    Lectures    on    Science,    Philosophy   and    Art. 

Taft,  William,  Ethics  in  Service. 

Hadley,  A.   T.,  Standards  of  Public  Morality. 

Edie,   Lionel   D.,    Current  Social  and  Industrial  Forces. 

Binder,   Rudolph   M.,   Major   Social   Problems. 

Binder,  Rudolph,  M.,  Health  and  Social  Progress. 


44388 


CHAPTER    IV 

THE  SOCIAL  SCIENCES 

(Continued) 

Sociology. — Sociology  is  the  science  which  treats  of 
man's  behavior  in  groups.  Sociology,  like  the  other 
social  sciences,  does  not  concern  itself  with  providing  a 
means  of  modifying  human  conduct.  It  is  content  to 
explain  human  conduct.  True,  statesmen  and  social  re- 
formers may  take  the  facts  and  theories  Worked  out  by 
sociologists  as  the  basis  for  political  or  voluntary  social 
action,  but  their  plans  for  affecting  human  conduct  are 
the  results  of  their  own  judgment  and  not  of  any  com- 
prehensive plan  of  proper  human  conduct  outlined  by 
sociology.  Indeed,  as  an  eminent  contemporary  sociolo- 
gist points  out,  actual  control  of  human  conduct  has  been 
most  effectively  exercised  by  political  organization  and 
religious  teaching.^ 

^Giddings,  in  his  Lecture  on  Sociology,  published  by  Columbia 
University  in  the  volume  entitled  Lectures  on  Science,  Philosophy 
and  Art,  summarizes  as  follows  the  propositions  made  by  Herbert 
Spencer,  and  apparently  approves  the  system  thus  summarized  as 
"a  compact  and  logical"  statement  not  only  of  Spencer's  sociology 
but  of  the  content  of  sociology  generally.  1  have  added  to  the 
summary  a  paragraph  from  Professor  Giddings's  Lecture  to  show 
that   this   latter   statement   is   not   wholly   true. 

"Societies   are   organisms,   or  they   are   super-organic  aggregates. 

"Between  societies  and  environing  bodies,  as  between  other 
finite  aggregates  in  nature,  there  is  an  equilibration  of  energy. 
There  is  equilibration  between  society  and  society,  between  one 
social   group   and   another,   between    one    social   class   and   another. 

"Equilibration  between  society  and  society,  between  societies 
and  their  environment,  takes  the  form  of  a  struggle  for  existence 

38 


THE   SOCIAL   SCIENCES  39 

among  societies-.     Conflict  becomes  an  habitual  activity  of  society. 

"In  this  struggle  for  existence  fear  of  the  living  and  of  the 
dead  arises.  Fear  of  the  living,  supplementing  conflict,  becomes 
the  root  of  political  control.  Fear  of  the  dead  becomes  the  root 
of   religious   control. 

"Organized  and  directed  by  political  and  religious  control,  ha- 
bitual conflict  becomes  militarism.  Militarism  moulds  character 
and  conduct  and  social  organization  into  fitness  for  habitual  war- 
fare. 

"iVIilitarism  combines  small  social  groups  into  larger  ones,  these 
into  larger  and  yet  larger  ones.  It  achieves  social  integration. 
This  process  widens  the  area  within  which  an  increasingly  large 
proportion  of  the  population  is  habitually  at  peace  and  industrially 
employed. 

"Habitual  peace  and  industry  mould  character,  conduct  and 
social  organization  into  fitness  for  peaceful,  friendly,  sympathetic 
life. 

"In  the  peaceful  type  of  society  coercion  diminishes,  spontaneity 
and  individual  initiative  increase.  Social  organization  becomes 
plastic,  and  individuals  moving  freely  from  place  to  place  change 
their  social  relations  without  destroying  social  cohesion,  the  ele- 
ments of  which  are  sympathy  and  knowledge  in  place  of  primitive 
force. 

"The  change  from  militarism  to  industrialism  depends  upon  the 
extent  of  the  equilibration  of  energy  between  any  given  society  and 
its  neighboring  societies,  between  the  societies  of  any  given  race 
and  those  of  other  races,  between  society  in  general  and  its  physical 
environment.  Peaceful  industrialism  cannot  fairly  be  established 
until   the  equilibrium  of   nations   and   of   races   is   established. 

"In  society,  as  in  other  finite  aggregates,  the  extent  of  differ- 
entiation and  the  total  complexity  of  all  the  evolutionary  processes 
depend  upon  the  rate  at  which  integration  proceeds.  The  slower 
the  rate  the  more  complete  and  satisfactory  is  the  evolution. 

"Mr.  Spencer  organized  sociology  as  a  science,  and  he  demon- 
strated principles  which  must  always  hold  a  central  place  in 
sociological  theory,  whatever  its  further  development  may  be. 
But  his  analyses  are  by  no  means  always  exhaustive,  and  he  raised 
many  questions   which   he   left  unanswered. 

"The  most  fundamental  question  that  his  exposition  left  open, 
and  over  which  dispute  soon  arose,  is  that  of  the  true  nature  of 
the  social  aggregate.  Is  it,  strictly  speaking,  an  organism,  or  is 
it  more  accurately  described  by  Spencer's  alternative  phrase — a 
super-organic  aggregate?  A  group  of  able  writers,  among  whom 
Schaftle  and  Lilienfeld  in  Germany,  and  Rene  Worms  in  France, 
have  been  most  active,  has  strongly  insisted  that  the  typical  so- 
ciety, consisting  of  individuals  both  dwelling  and  working  together, 
is  as  truly  an  organism  as  is  the  animal  or  the  vegetal  body  com- 
posed of  cells  and  differentiated  into  mutually  dependent  tissues 
and  organs.  Pre-eminently  fruitful  work,  however,  has  been  done 
by  investigators,  who,  conceiving  society  as  a  super-organic  prod- 
uct, regard  it  as  essentially  a  psychological  phenomenon. 


40  PRINCIPLES  OF  BUSINESS 

Some  discussion  has  been  indulged  in  by  sociologists 
as  to  whether  the  science  of  sociology  is  an  independent 
science  or  whether  it  is  a  complex  of  different  parts  of 
older  social  sciences/  But  all  sociologists,  of  course, 
are  agreed  that  sociology  as  a  science  must  draw  heavily 
upon  the  other  sciences — witness  the  fact,  for  example, 
that  sociology  is  sometimes  called  social  psychology  or 
by  some  other  such  name.  The  fact  is  that  biology,  psy- 
chology, anthropology  and  economies  are  all  inter- 
related. 

What  can  sociology  do  for  business? — Modern  so- 
ciologists are  making  large  demands  at  present  on  the 
science  of  statistics  in  order  to  formulate  generalizations 
about  human  conduct.  Claims  are  made  for  it,  that  with 
the  aid  of  statistical  method,  sociology  "promises  to  be- 
come in  a  rather  high  degree  an  exact  science."  These 
claims  are  so  interesting  to  the  business  man  that  we 
may  quote  them  at  length  in  the  words  of  Professor 
Giddings : 

"If  there  is  a  struggle  for  existence  in  which  certain 

organisms  perish,  while  others  survive,  it  is  plain  that 

the  survivors  tend,  under  given  environmental  conditions, 

to  become  alike,  since  all  must  possess  those  structural 

peculiarities  and  those  habits  which  give  advantage  over 

competitors.     The  more  specific  the  conditions  and  fierce 

the  struggle,  the  more  surely  is  an  individual  marked  for 

destruction  if  he  varies  greatly  from  the  successful  type 

or  norm.     Now  most  peculiarities  of  organic  structure 

and  activity  admit  of  measuring — like  height,  of  count- 

1  Small,  General  Sociology,  p.  40,  holds  the  latter  view,  while 
Giddings,  The  Principles  of  Sociol  igy,  chap,  i,  holds  the  former 
view. 


THE   SOCIAL   SCIENCES  41 

ing — like  the  number  of  veins  in  a  leaf.  The  measures 
or  other  numbers  relating  to  thousands  of  individuals 
may  be  brought  together  in  columns  or  tables.  Their 
averages  may  be  obtained,  and  the  difference  between 
each  number  and  the  average  of  all  numbers  of  the  same 
class  may  be  found.  Then,  if  the  numbers,  as  shown  by 
their  deviations,  have  a  wide  dispersion  from  the  aver- 
age, we  know  that  the  individuals  to  which  they  relate 
have  not  for  a  long  time  been  subjected  to  a  relatively 
intense  struggle  for  existence.  It  has  been  possible  for 
them  to  vary  within  wide  limits,  and  yet  to  survive.  If, 
on  the  other  hand,  the  numbers  cluster  closely  about  their 
average,  we  know  that  the  individuals  to  which  they  re- 
fer have  been  subjected  to  a  severe  unifying  pressure. 
They  have  ceased  to  var}'  because  such  as  strayed  frorn 
type  lost  their  hold  on  life. 

"Ingenious  applications  of  this  principle  in  connection 
with  the  curve  of  error,  and  other  statistical  devices, 
which  have  been  developed  by  Sir  Francis  Galton,  Pro- 
fessor Karl  Pearson,  and  many  others,  have  proved  to 
be  of  inestimable  value  in  biology,  in  psychology,  and  in 
anthropology.  There  is  reason  to  believe  that  in  sociol- 
ogy the  results  will  presently  be  yet  more  satisfying, 
since  in  all  statistical  operations  the  possibilities  of  error 
diminish  as  the  number  of  numerical  items  of  any  given 
class,  and  happening  to  be  available  for  analysis,  in- 
creases. Sociolog}'  will  pre-eminently  enjoy  this  advan- 
tage. 

"The  first  attempt  to  make  a  statistical  statement  of 
the  greatest  possible  number  of  sociological  prol)lems, 
and  to  indicate  their  statistical  solutions,   we  owe  to 


42  PRINCIPLES  OF  BUSINESS 

Professor  Mayo-Smith.  It  was  possible  when  he  wrote 
to  give  precision  to  statistical  studies  of  population  at  one 
end  of  the  series  of  social  phenomena,  to  studies  of  or- 
ganization and  welfare  at  the  other  end.  The  inter- 
mediate and  crucial  problems  of  mental  type  and  vari- 
ability, of  selective  social  choice,  and  of  social  pressure 
could  not  then  be  handled  by  statistical  methods.  It  is 
becoming  possible  now  to  state  and  solve  them  quanti- 
tatively by  employing  the  new  methodical  devices  to 
which  brief  reference  has  been  made.  For  example, 
Professor  Benini,  of  Pavi,  has  demonstrated  that  it  is  a 
comparatively  simple  matter  to  measure  a  phenomenon 
seemingly  so  elusive  as  the  consciousness  of  kind.  Tabu- 
lating the  Italian  statistics  of  marriage,  he  ascertains 
how  many  bachelors  would  marry  maidens,  how  many 
widowers  would  marry  widows,  how  many  men  of  a 
given  age-class  would  marry  women  of  the  same  age- 
class,  how  many  men  of  a  given  nationality  would  marry 
women  of  the  same  nationality,  how  many  Catholics 
would  marry  Catholics,  how  many  men  following  a  given 
occupation  would  marry  women  whose  fathers  followed 
the  same  occupation,  if  all  of  these  combinations  hap- 
pened strictly  by  chance.  Comparing  the  probable  num- 
bers with  the  actual  selections,  he  obtains  index  numbers 
of  selective  choice  or  preference,  thereby  determining  the 
exact  intensity  with  which,  as  Empedocles  remarked, 
'like  desires  like.'  This  method  is  applicable  to  a  wide 
range  of  social  choices. 

"By  a  somewhat  different  procedure  it  is  possible  to 
measure  social  pressure.  In  modern  times  social  pres- 
sure is  definitely  distributed  through  provisions  of  stat- 


THE    SOCIAL    SCIENCES  43 

Ute  law,  and  these  admit  of  tabulations,  from  which 
index  numbers  we  shall  presently  measure  the  varying 
degrees  of  social  pressure  as  we  now  measure  changes 
in  the  purchasing  power  of  gold.  It  is  hardly  too  much 
to  say,  therefore,  that  all  of  the  chief  theorems  of  soci- 
ology probably  admit  of  quantitative  statement,  solution 
and  correlation." 

That  these  claims  may  be  largely  overestimated  is  the 
contention  of  a  well-known  English  economist: 

"The  science  and  art  of  society  have  suffered  so  much 
from  want  of  exact  and  measured  information  that  it  is 
only  right  and  natural  for  immense  importance  to  be 
attached  to  the  collection  of  masses  of  ordered  and  meas- 
ured social  facts.  If  a  sufficient  number  of  trained  in- 
vestigators could  be  set  to  work  to  gather,  measure,  sift 
and  tabulate  the  various  orders  of  crude  fact  relating  to 
the  employment,  wages,  housing,  expenditure,  health, 
thrift,  education,  and  other  concrete  conditions  of  the 
poorer  grades  of  town  and  country  dwellers,  it  seems  as 
if  a  number  of  accurate  and  valid  generalizations  would 
emerge  by  clear  induction  upon  which  could  be  con- 
structed an  absolutely  scientific  treatment  of  poverty. 
Or,  again,  to  take  a  narrower  and  more  distinctively 
economic  issue,  that  of  the  shorter  working  day.  If  a 
careful  series  of  observations  and  experiments  could  be 
made  in  a  number  of  representative  businesses,  as  to 
the  effect  upon  the  size,  cost  and  quality  of  output  pro- 
duced by  given  reductions  in  the  hours  of  labor  among 
various  classes  of  workers,  it  might  appear  as  if  an  accu- 
rately graded  social  economy  of  the  working  day  could 
be  attained  by  calculations. 


44  PRINCIPLES  OF  BUSINESS 

"But  though  statesmen,  philanthropists  and  reformers 
are  more  and  more  influenced  in  their  judgments  and 
poHcies  by  these  measured  facts,  no  safe  mechanical 
rules  for  the  guidance  of  their  conduct  in  any  social  prob- 
lem can  be  based  upon  them.  The  facts  and  figures 
which  appear  so  hard  and  so  reliable  are  often  very  soft 
and  ineffective  tools  for  the  social  practitioner.  There 
are  several  defects  in  them  regarded  as  instruments  of 
social  progress. 

"It  is  hardly  ever  possible  to  prove  causation  by  means 
of  them.  You  may  obtain  the  most  exact  statistics  of 
housing  conditions  and  of  death-rates  for  the  population 
of  a  group  of  towns,  but  you  cannot  prove  to  what  ex- 
tent 'back  to  back'  houses  affect  infant  mortality.  No 
figures  professing  to  measure  the  causal  connection  be- 
tween drink  and  crime  or  insanity,  income  and  birth- 
rate, or  any  other  two  social  phenomena,  possess  the 
degree  of  validity  completely  in  any  organic  or  social 
problem,  and  you  can  never  know  how  far  you  have 
failed  to  isolate  them.  You  may,  indeed,  sufficiently 
obtain  practical  proof  of  organic  causation,  but  you  can 
seldom  express  this  causation  in  terms  of  any  quantita- 
tive accuracy.  Still  more  is  this  true  of  psychological 
and  social  problems.  A  purely  descriptive  science  of 
society  may  attain  a  considerable  degree  of  quantitative 
accuracy,  but  the  laws  expressing  the  causal  relations  of 
these  measured  facts  will  always  lack  the  certainty  of 
operation  and  the  measurability  of  action  belonging  to 
the  laws  of  chemistry  and  physics. 

"Now  the  chief  facts  with  which  the  statesman  and 
the  social  reformer  are  concerned  in  forming  judgments 


THE    SOCIAL    SCIENCES  45 

and  policies  are  these  laws  of  causal  relation,  and  not 
the  crude  measured  facts  that  constitute  the  raw  mate- 
rial of  statistics.  This  comparative  inexactitude  or  lack 
of  rigidity  in  the  laws  of  social  science  constitutes  the 
first  difficulty  in  applying  the  science  to  the  art  of  social 
conduct  with  the  same  amount  of  confidence  with  which 
the  laws  of  physics  and  chemistry  are  applied  to  the 
mechanical  arts.  But  another  difficulty  quite  as  grave  as 
this  want  of  rigidity  in  social  facts  is  the  instability  of 
the  standard.  In  all  processes  of  physical  measurement 
it  is  customary  to  make  allowances  for  errors  due  to  what 
is  called  'the  personal  equation,'  abnormalities  of  obser- 
vation in  the  experimentef.  But  the  standard  of  human 
valuation,  the  enlightened  common  sense  of  a  community 
applied  to  interpret  social  phenomena  in  terms  of  'utility' 
or  'welfare'  will  evidently  be  subject  to  much  wider  varia- 
tions, and  the  interpretation  of  this  standard  by  states- 
men, or  other  individual  agents  of  society,  will  be  subject 
again  to  wide  errors  of  personal  bias. 

"Illustrating  from  the  economic  sphere  which  is  our 
concern,  that  specialization  of  industrial  life  which  has 
made  three-quarters  of  our  population  town-dwellers  and 
is  making  our  nation  continually  more  dependent  upon 
foreign  supplies  of  food,  will  have  a  very  different  value 
set  on  it  by  the  narrower  nationalism  which  believes  the 
interests  and  ambitions  of  nations  to  be  irreconcilable, 
and  by  the  wider  political  outlook  which  conceives  the 
economic  interdependence  of  nations  as  in  itself  desirable 
and  as  the  best  guarantee  of  national  security.  Or  again, 
a  difference  of  view  or  sentiment  regarding  the  relative 
worth  of  the  personal  qualities  of  enterprise  and  self- 


46  PRINCIPLES  OF  BUSINESS 

reliance  on  the  one  hand,  of  plodding  industry  and  social- 
ity upon  the  other,  must  materially  affect  the  values  given 
to  such  phenomena  as  emigration,  public  provision 
against  unemployment,  co-partnership,  taxation  of  high 
incomes  or  inheritances.  Indeed  it  is  quite  manifest  that 
with  every  difference  of  the  range  of  sympathy  and  im- 
agination the  meaning  which  enlightened  common  sense 
will  give  to  social  welfare,  and  to  every  fact  submitted 
to  this  test,  will  vary."^ 

Practical  sociological  work. — Sociological  work,  so- 
called  by  some  business  houses,  has  taken  a  very  practical 
form-  in  what  is  known  as  maintenance' work.  The 
scope  of  this  work  has  been  defined  by  the  Employers' 
Welfare  Department  of  the  National  Civic  Federation 
in  the  following  words : 

"Welfare  Work  is  the  improving  of  working  and  liv- 
ing conditions  of  employees  by  employers;  and  is  appli- 
cable to  stores,  factories,  mines  and  railroads  as  well  as 
public  institutions,  Federal,  state  and  municipal. 

"In  promoting  the  work,  it  is  recognized  that  the  first 
essentials  to  the  welfare  of  employees  are  steady  work, 
an  equitable  wage  and  reasonable  hours  of  labor;  but 
that  the  employer  has  a  further  obligation. 

"It  is  advocated  that  the  beginning  of  all  welfare  work 
should  be  directed  toward  meeting  the  pressing  necessi- 
ties for  the  physical  well-being  of  employees  in  their 
work  places. 

"Some  of  the  subjects  involved  in  Maintenance  work  are  : 

Sanitary  work  places. — Systems  for  providing  pure 

iHobson,  Work  and  Wealth,  pp.  322-324. 

2  Tlie  Welfare  work  of  the  Colorado  Fuel  and  Iron  Company  is 
conducted  by  its  "Sociological  Department." 


THE    SOCIAL    SCIENCES  47 

drinking  water;  for  ventilation,  including  the  cooling  of 
superheated  places,  and  devices  for  exhausting  dust  and 
removing  gases;  for  lighting  work  places,  and  for  safe- 
guards against  industrial  accidents ;  wash  rooms,  with  hot 
and  cold  water,  towels  and  soap ;  shower  baths  for 
moulders  and  stationary  firemen;  emergency  hospitals; 
locker  rooms;  seats  for  women;  laundries  for  men's  over- 
alls or  women's  uniforms;  the  use  of  elevators  for 
women ;  and  luncheon  rooms. 

Recreation. — "The  social  hall  for  dancing  parties, 
concerts,  theatricals,  billiards,  pool  or  bowling;  the  gym- 
nasium, athletic  field,  roof  garden,  vacations  and  summer 
excursions  for  employees;  and  rest  rooms  or  trainmen's 
rest  houses. 

Educational. — "Classes  for  apprentices ;  in  cooking, 
dressmaking,  millinery;  first  aid  to  the  injured;  night 
classes  for  technical  training;  kindergartens  and  libraries. 

Housing. — "Homes  rented  or  sold  to  employees,  and 
boarding  houses. 

Provident  funds. — "(a)  For  wage  earners'  insurance, 
affecting  governmental  as  well  as  employees  in  private 
enterprises,  including:  i.  Compensation  for  victimiS  of 
industrial  accidents;  2.  Employers'  voluntary  sick,  acci- 
dent and  death  funds;  3.  Retirement  funds  or  old  age 
pensions,  and  (b)  Employers"  plans  for  savings  or  lend- 
ing money  in  times  of  stress." 

Value  of  maintenance  work. — An  employer  recently 
told  how  a  newspaper  in  his  town  carried  for  six  weeks  an 
advertisement  for  women  workers  inserted  by  a  local 
factory.      The    factory's    advertisement    stated    that   the 


48  PRINCIPLES  OF  BUSINESS 

women  would  get  free  lunches,  would  have  recreation 
periods  and  would  be  entitled  to  the  free  use  of  gym- 
nasium, baths  and  library.  He  added  that  he  himself 
also  advertised  for  women  workers,  his  own  advertise- 
ment appearing  only  once.  This  advertisement  offered 
not  welfare  service  but  a  dollar  a  week  more  wages  than 
the  other  manufacturer  offered.  He  got  his  employees 
in  one  day;  the  other  manufacturer  had  to  advertise  for 
six  weeks.  Does  welfare  work  pay?  Concretely  in  this 
case  it  did  not  bring  results.  But  it  must  be  remembered 
that  the  exponents  of  maintenance  work  do  not  measure 
the  value  of  their  service  in  single  instances  any  more  than 
one  would  measure  the  value  of  feathers  or  straw  as 
desirable  things  to  lie  upon  by  lying  upon  one  feather 
or  one  straw. 

Economics. — Perhaps  of  all  the  sciences  that  have 
been  developed  none  is  so  important  and  interesting  to 
the  business  man  as  the  social  science  of  business  called 
economics.  Organized  society  through  its  regularly  con- 
stituted political  divisions  has  been  so  great  a  factor  in 
man's  struggle  with  nature  that  the  science  has  sometimes 
been  called  political  economy.  Indeed,  from  the  four- 
teenth century  down  to  the  middle  of  the  eighteenth  cen- 
tury such  economic  discussion  as  there  was  concerned  it- 
self chiefly  with  the  lousiness  conditions  under  which  states 
could  best  prosper.  Earlier  economic  discussion  concerned 
itself  with  moral  issues,  such  as  wh'ether  it  was  right  to 
charge  interest.  Modern  economics,  on  the  other  hand, 
which  by  the  way  is  usually  stated  as  beginning  with 
Adam  Smith's  publication  of  the  VVealtJi  of  Nations  in 
1776,   concerns   itself   with   an   explanation   of   business 


THE    SOCIAL    SCIENCES  49 

phenomena  as  they  affect  society  and  as  they  affect  the 
individual.  It  is  perhaps  fair  to  state  that  economics 
as  a  science  is  not  static  and  that  in  the  coming  genera- 
tion its  chief  concern  will  be  the  promotion  of  individual 
welfare  through  social  regulation  of  business  enterprises. 

The  three  phases  of  socialization  of  industry. — 
Every  generous-minded  man  will  agree  that  the  most 
desirable  social  organization  is  that  which  encourages 
the  individual  to  overcome  the  forces  of  nature  most 
effectively — that  is,  to  contribute  most  toward  produc- 
tion— and  which  distributes  most  evenly  among  all  men 
the  products  of  social  efforts.  To  the  objection  that 
distribution  should  be  made  equitably  instead  of  evenly 
— that  is,  that  men  should  receive  shares  of  the  social 
income  not  evenly  but  in  proportion  to  what  they  con- 
tribute— the  answer  can  be  offered  that  under  proper 
social  conditions  the  work  of  men  would  be  apportioned 
evenly  and  their  shares  of  income  would  be  even  and 
equitable.  From  this  we  can  see  how  economics  depends 
on  the  other  sciences. 

Starting  with  the  proposition  that  each  individual  is 
placed  in  this  world  fortuitousl}^  in  favorable  or  in  un- 
favorable circumstances  and  that  the  world  owes  him  not 
a  living  but  the  right  to  make  a  living  and  to  enjoy  it,  we 
can  see  how  sociology,  psychology  and  a  number  of  other 
sciences  are  going  to  be  called  into  action  to  modify  ex- 
isting conditions.  There  is  no  panacea.  Indeed,  people 
are  apt  to  confuse  the  means  with  the  ends.  No  reform 
can  be  an  end.  Its  true  function  must  be  to  bring  about 
the  desirable  ends  of  increased  production  and  just  dis- 
tribution  of   the   social    income.     Whether   such   a   de- 


50  PRINCIPLES  OF  BUSINESS 

sideratum  can  be  achieved  by  individual  effort  and  un- 
regulated competition,  or  by  governmentally  regulated 
business  or  by  business  largely  owned  and  operated  by 
the  Government  is  a  question  often  erroneously  asked. 
What  should  be  inquired  about  is,  Should  the  next  step 
in  social  progress  be  made  through  one  or  the  other  of 
these  means.  At  present  it  must  be  confessed  that  we 
have  moved  quite  out  of  the  laisscs  faire  regime  inaugur- 
ated in  the  middle  of  the  eighteenth  century.  Indeed, 
we  may  be  well  on  our  way  toward  what  is  generally  con- 
sidered the  third  step  in  the  socialization  of  industry — 
government  ownership. 

Early  history  of  economic  science. — As  we  have 
seen,  economics  as  a  separate  science  was  really  born 
with  Adam  Smith's  Wealth  of  Nations.  Smith  was 
followed  by  several  other  English  economists  who 
made  up  what  is  now  called  the  Classical  School. 
The  purpose  of  this  school  was  to  explain  the  laws  of 
rent,  wages  and  profits.  Ricardo's  theory  of  rent  is 
still  generally  followed  by  economists.  But  his  theory  of 
wages  has  been  discarded.  He  held  that  capital  con- 
stituted a  fund  out  of  which  wages  could  l>e  paid  and 
that  nothing  else  could  determine  the  amount  of  wages 
except  the  size  of  the  fund  and  the  number  of  wage- 
earners — i.e.,  the  population,  drawing  upon  the  fund. 
This  is  the  so-called  "wages  fund"  theory.  It  explained, 
so  the  classical  school  generally  held,  the  short-lived  vari- 
ations in  wages.  The  longer  tendencies  in  wage  levels 
were  explained  by  what  has  come  to  be  known  as  the 
"iron  law"  of  wages.  This  so-called  law  follows  the 
doctrine  of   Malthus,   that   increase   in   population   con- 


THE    SOCIAL    SCIENCES  51 

stantly  tends  to  out-pace  increase  in  food  supply.  Hence, 
these  economists  believed  that  as  wages  increased,  pop- 
ulation was  still  further  encouraged  to  increase  rapidly 
until  the  increase  was  stopped  by  the  limits  fixed  by  the 
food  supply.  From  all  this  it  followed  that  wages  would 
be  kept  down  inexorably  to  an  amount  sufficient  to  meet 
the  bare  necessaries  of  life.  A  dismal  outlook  indeed  it 
presented  to  the  laborer,  and  indeed  it  earned  for  eco- 
nomics the  title,  "The  Dismal  Science."' 

Relation  of  Classical  School  to  practical  life, — 
The  classical  school  of  economists  exerted  an  impor- 
tant influence  on  practical  life.  Their  theories  led  to  a 
full  acceptance  of  the  doctrine  of  laissez  faire.  Free  com- 
petition thus  got  a  strong  start  in  the  early  part  of  the 
nineteenth  century.  "In  the  completed  form  to  which  it 
was  brought  by  the  work  of  Senior,  the  classical  sys- 
tem had  at  least  the  merit  of  simplicity.  The  produc- 
tion and  distribution  of  wealth  seemed  to  be  completely 
explained  by  half  a  dozen  clean-cut  propositions.  From 
them  seemed  to  follow  by  inexorable  logic  the  prin- 
ciple that  governmental  interference  with  industrial  re- 
lations must  prove  futile,  even  when  not  positively 
harmful."^ 

Criticism  of  the  Classical  School. — Professor  Seager 

has  sho\m"  that  the  classical  system  of  economies  was 

simultaneously  attacked  from  five  different  sources.     In 

the  first  place,  many  of  the  leaders  changed  some  of  their 

earlier  opinions,  and  this  gave  ground  for  the  moralists 

who  insisted  that  the  formulators  of  the  "dismal  science" 

^Lecture  on   Economics,  by  Henry  Rogers   Seager,   in   Columbia 
Universitv  Lectures  on  Science,  Philosophy  and  Art. 
'  Cit.  obit. 


52  PRINCIPLES  OF  BUSINESS 

were  "closet  philosophers"  and  out  of  touch  with  real 
life.  "Their  desire  for  simplicity  led  them  sometimes  to 
argue  as  though  all  mankind  had  the  same  habits  of  mind 
as  town  men."^  Thus  they  constructed  "economic  man" 
who  frequently  became  more  vivid  in  the  mind  under  the 
name  of  Robinson  Crusoe,  but  who  in  no  sense  could  be 
said  to  embody  all  the  attributes  of  mankind.  (See  dis- 
cussion in  previous  chapter.) 

The  socialists  accepted  the  doctrines  of  the  classical 
school  because  they  led  to  the  conclusions,  so  Karl  Marx 
held,  that  all  incomes  except  wages  are  the  result  of 
legalized  robbery.  Thus  while  accepting  classical  theories, 
the  sociaKsts  rejected  the  classical  conclusions. 

A  new  school  of  economists,  called  the  German  His- 
torical School,  attacked  classical  economics  on  the  ground 
that  they  were  not  of  universal  application  either  in  point 
of  time  or  in  point  of  place,  and  they  drew  upon  their 
historical  studies  to  back  up  their  contentions.  This 
form  of  reasoning  was  also  sustained  by  the  evolution- 
ary doctrines  of  biological  science — doctrines  that  were 
beginning  in  the  middle  of  the  first  half  of  the  nine- 
teenth century  to  be  generally  understood  and  generally 
accepted. 

Finally  the  classical  sc!''ool  was  directly  attacked  by 
the  economists  themselves. 

Modern  economics. — Modern  economics  has  ceased 
to  look  upon  business  life  as  a  simple  affair.  All  of  the 
influences  that  were  brought  to  bear  upon  the  economists 
to  desert  the  teachings  of  the  classical  school  have  more 
or  less  tended  to  drive  home  the  lesson  that  society  is 

1  Marshall,  Principles  of  Economics,  Appendix  B. 


THE    SOCIAL    SCIENCES  53 

neither  static  nor  simple/  "There  is  no  fund,  existing 
like  a  war  chest,  from  which  labor  can  be  paid.  It 
(wealth)  is  not  an  enormous  stock  of  goods  accumulated 
in  the  past  and  ever  growing,  which  might  be  drawn  on 
with  no  more  evil  consequences  than  leaving  a  gap.  It 
is  not  like  the  treasure  of  a  Greek  temple,  which  passed, 
on  conquest,  from  the  service  of  the  gods  to  the  service 
of  man,  or  like  a  landed  estate  which  might  be  confiscated 
and  divided  among  small  holders.  It  is,  in  fact,  a  stream 
— a  constant  stream — not  a  reservoir.  And,  being  so, 
it  might  dry  up  like  other  streams. 

"The  typical  form  of  wealth  today,  in  fact,  is  in  the 
shape  of  Power — not  stuff  in  the  w^arehouse,  but  the 
mill  which  fills  it."  Keep  the  mill  running,  and  the 
warehouse  will  every  day  fill  and  evening  empty.  But 
let  any  of  the  many  factors  in  the  mill,  that  unit  of 
production  kept  together  by  the  most  complex  and  del- 
icate organization,  start  asunder — any  factor,  for  the 
more  perfect  the  organization,  the  smaller  the  thing 
which  will  wreck  it — let  there  be  any  break  in  the  proc- 
ess. I  say,  from  a  strike  of  the  workers  to  a  leak  in 
the  boiler — and  what  happens?  Why,  nothing  goes  into 
the  warehouse.  The  stream  of  wealth  has  ceased  to 
flow.'"' 

^"The  inadequacy  of  the  classical  theories — if  we  except  the 
wages-fund  theory,  the  most  serious,  not  to  say  vicious  error  of 
the  old  writers — came  from  their  being  only  half-true  rather  than 
untrue."     Seager,  in  Columb'M  University  Lectures. 

2  Cf.  Modern  theory  of  matter. 

■'  Smart's  Second  Thoiujhts  of  an  Economist,  p.  46.  Compare 
with  this  statement  of  wealth  the  definitions  of  capital  and  of  in- 
come by  the  American  economist,  Professor  Irving  Fisher :  "A 
stock  of  zvcalth  existing  at  a  given  instant  of  time  is  called  capital; 
a  flozu  of  benefits  from  wealth  through  a  period  of  time  is  called 
income."    Elementary  Principles  of  Economies,  p.  38. 


54  PRINCIPLES  OF  BUSINESS 

Political  science  and  business. — If  we  had  the  space 
it  would  be  interesting  to  develop  at  length  the  historical 
aspect  of  the  relation  of  government  to  business.  Many 
business  men  feel  that  anti-trust  statutes,  tax  laws  and 
the  like  burdens  and  limitations  of  government  have 
culminated  in  the  necessities  of  the  war  after  a  short 
growth  dating  back  say  to  the  Sherman  Act  of  1890  or 
perhaps  three  years  earlier  to  the  Interstate  Commerce 
Act.  The  fact  is  that  several  centuries  ago  and  during  a 
period  antedating  that  time,  public  administration  in 
practice  and  in  theory  concerned  itself  much  more  with 
business  than  it  does  now.  Indeed  the  relation  between 
the  form  of  political  organization  and  the  stage  of  eco- 
nomic evolution  of  a  given  territory  has  always  been  very 
intimate.  "The  idea  that  economic  life  has  ever  been  a 
process  mainly  dependent  on  individual  action — an  idea 
based  on  the  impression  that  it  is  concerned  merely  with 
methods  of  satisfying  individual  needs — is  mistaken  with 
regard  to  all  stages  of  human  civilization,  and  in  some 
respects  it  is  more  mistaken  the  further  we  go  back."  * 

But  it  does  remain  true  that  State  and  business  do 
draw  near  and  again  separate.  One  has  but  to  recall  the 
situation  as  it  existed  shortly  after  the  Civil  War,  when 
the  tariff  and  the  currency  were  about  the  only  important 
matters  that  business  men  had  to  consider  as  political  ele- 
ments affecting  their  businesses.  Now,  the  hand  of  the 
State  reaches  down  into  every  nook  and  corner  of  busi- 
ness. 

The  right  of  freedom  of  contract. — The  chaos  of  the 
Middle  Ages  yielded  freedom  of  contract  as  a  gift  no  less 

^  Schmoller's  The  Mercantile  System,  p.  4. 


THE    SOCIAL    SCIENCES  55 

precious  than  freedom  of  religion.  But  freedom  of  con- 
tract— the  right  to  pursue  any  vocation  that  is  not  preda- 
tory and  the  right  to  acquire,  hold  and  transmit  property 
— has  become  an  historical  doctrine.  It  is  not  the  place 
here  to  trace  the  assault  on  the  doctrine  and  its  capitula- 
tion to  modern  theories.  Certain  it  is  today  that  the 
individual's  right  to  freedom  of  contract  is  wholly  sub- 
ordinate to  society's  wishes  and  whims.  The  guaranties 
of  civil  liberty  that  were  first  written  in  Magna  Charta 
and  reiterated  in  the  United  States  Constitution  have 
been  rendered  futile  in  the  rise  of  what  is  known  as  the 
*'police  power." 

History  of  the  "police  power." — The  control  of  busi- 
ness through  the  exercise  of  what  is  known  as  the  "police 
power"  is  so  important,  so  all-pervading,  and  so  contrary 
to  what  the  mature  business  men  of  this  day  learned  in 
their  boyhood  as  the  theory  of  civil  rights,  that  we  may 
explain  it  at  some  length. 

The  story  begins  with  a  Trinity  Church  burying 
ground  in  New  York  City.  In  1823  a  law  was  passed 
prohibiting  burial  within  the  city  limits.  Since  the  cor- 
poration, consequently,  was  deprived  of  the  use  of  its 
property  for  the  purpose  for  which  it  was  intended,  and 
since  the  State  refused  compensation,  the  Church  claimed 
that  its  property  had  been  confiscated.  But  the  New 
York  Court  of  Appeals  held  that,  in  the  exercise  of  its 
"police  power,"  the  State  for  the  protection  of  the  health 
of  the  community  could  sweep  aside  the  written  guaran- 
tees of  the  Constitution.^  A  little  later  the  United  States 
Supreme  Court  adopted  this  doctrine,  and  it  has  since 

^  Coates  vs.  Mayor  of  N.  ¥.,  7  Co  wen,  585. 


56  PRINCIPLES  OF  BUSINESS 

done  duty  in  numberless  ways,  including  the  enforcement 
of  labor-hour  laws,  and  more  recently  in  the  prohibition 
of  what  some  people  think  is-  the  very  innocent  occupation 
of  selling  and  redeeming  trading  stamps.^ 

Effect  of  war  on  social  activities. — There  can  be  no 
final  solutions  of  social  problems.  As  conditions  change, 
the  rules  of  social  conduct  must  change.  Each  change  that 
is  wrought  probably  leaves  some  enduring  effect  on  the 
social  structure  but  this  effect  is  gradually  worn  away  by 
the  changes  resulting  from  newly  arising  conditions.  In 
a  period  of  stress — during  a  war,  or  locally  during  a  flood 
or  fire — social  activities  or  group  activities  multiply. 
During  the  European  War,  transportation,  production, 
consumption,  and  credit  were  all  brought  under  govern- 
ment control.  In  districts  subject  to  forest  fires  the 
proper  official  may  place  a  shovel  and  ax  in  the  hands  of 
the  citizen  and  compel  him  to  work  for  a  pittance.  But 
influences  working  for  socialization  or  individualism  are 
more  subtle  than  is  here  made  to  appear.  The  stalwart 
individualism  of  the  British  during  the  nineteenth  century 
was   undoubtedly   a   reaction    from   the   excesses   of   the 

^  See  Rast  vs.  Van  Bcman  and  Lewis,  240  U.  S.,  p.  342  and  Tan- 
ner vs.  Little,  240  U.  S.,  p.  369.  In  the  trading  stamp  cases  the 
doctrine  of  the  police  power  has  been  pushed  to  the  utmost.  Up  to 
the  time  when  these  cases  were  decided,  the  aggrieved  business  man 
who  felt  that  his  civil  rights  were  being  invaded  by  tlie  State  could 
bring  the  matter  before  the  courts  and  ask  them  to  decide  whether 
or  not  his  use  of  his  property  really  was  a  detriment  to  the  wel- 
fare of  society.  But  in  these  cases  the  United  States  Supreme 
Court  held  that  the  question  in  each  case  is  a  matter  of  opinion 
and  tliat  the  legislature's  opinion  is  as  good  as  the  judiciary's,  pro- 
vided the  opiniun  is  based  on  facts  and  not  on  mere  prophecy.  See 
Brook  Adams,  Tlie  Theory  of  Social  Revolutions.  The  objections 
raised  by  Mr.  Adams  to  the  position  of  the  courts  have  been  quite 
fully  obviated  by  the  Trading  Stamp  Cases. 


THE  SOCIAL  SCIENCES  57 

French  Revolution.  And  it  is  not  unlikely  that  the  Bol- 
shevism of  Russia  will  retard  rather  than  promote  the 
progress  of  social  activity  in  America  and  elsewhere. 

The  future  of  Government  relation  to  business. — 
There  is  no  denying  that  the  pendulum  is  still  swinging 
away  from  individualism.  How  long  progress  will  con- 
tinue in  that  direction  before  it  is  felt  that  the  next  step 
should  be  taken  toward  individualism  it  is  difficult  to  say. 
Progress,  however,  will  probably  be  best  promoted  by 
synchronizing  the  two  movements,  just  as  the  circular 
motion  induced  by  the  sliding  back  and  forth  of  the  piston 
rod  is  synchronized  and  reconciled  with  the  forward 
movement  of  the  steam  locomotive.^ 

The  Government  as  a  promoter  of  business.— Many 
people  think  of  the  Government  as  an  organization  whose 
whole  purpose  is  to  protect  society  by  constantly  saying 
"Thou  shalt  not."  Inspection  laws,  labor  laws,  taxation 
and  the  like  do  emphasize  the  restraining  power  of 
government.  But  the  promotion  of  business  is  also  the 
business  of  government.  One  has  but  to  read  a  list  of 
the  various  bureaus  in  the  executive  departments  of  the 
Federal  Government  to  realize  how  much  is  done  to  pro- 
mote business.  Indeed  the  Post  Office,  the  Interior,  the 
Agriculture,  the  Commerce  and  the  Labor  Departments 
are  devoted  almost  entirely  to  that  end.  To  these  may  be 
added  the  Federal  Reserve  Board,  the  United  States  Ship- 
ping Board,  the  Smithsonian  Institution,  the  Pan-Ameri- 
can Union  and  the  Library  of  Congress.  Copyright  and 
trade-mark  and  patent  laws  all  evidence  the  Government's 

^  For  an  opposing  vie\/  see  Emile  Fagnet's  The  Cult  of  Incom- 
petence. 


58  PRINCIPLES  OF  BUSINESS 

interest  in  business  promotion.  If  there  is  any  criticism 
to  be  made,  it  should  be  directed  against  the  people  who 
do  not  know  of  or  do  not  use  the  facilities  which  the 
Government — Federal,  State  and  Municipal — offers. 

Business  men  and  the  law. — While  it  is  probably  im- 
possible to  make  an  exact  calculation,  we  may  be  safe  in 
saying  that  the  losses  due  to  ignorance  of  the  law,  dis- 
regard of  the  law  or  carelessness  in  applying  it,  are 
greater  annually  than  the  combined  annual  losses  due  to 
fire,  flood,  speculation  and  fraud.  Surely  every  business 
man  who  comes  in  contact  daily  with  other  members  of 
society  should  have  more  than  a  superficial  knowledge 
of  the  laws  governing  his  relations  to  them. 

Substantive  and  adjective  law^. — Much  of  the  busi- 
ness man's  contempt  for  the  law  is  misdirected.  The 
law  itself  is  a  logical  science  that  must  command  the  re- 
spect if  not  the  admiration  of  the  thinking  man.  Frail 
human  beings  administer  it,  and  therein  lies  its  weak- 
ness. 

Law  may  be  divided  first  into  criminal  and  civil  law. 
Criminal  law  governs  the  relations  of  the  individual  with 
the  State;  and  civil  law  the  relations  of  the  individual 
with  other  individuals. 

Criminal  law  in  many  ways  affects  business ;  there  are 
the  laws  against  business  fraud,  against  the  declaration 
of  dividends  from  capital,  against  doing  business  under 
a  fictitious  name  without  filing  a  certificate,  and  scores  of 
other  laws. 

Civil  law  is  divided  into  substantive  and  adjective  law. 
Substantive  law  is  that  in  which  the  business  man  is  most 
interested.     It  deals  with  the  primary  rights,  while  adjec- 


THE   SOCIAL   SCIENCES  59 

tive  law — of  interest  chiefly  to  lawyers — prescribes  how 
those  rights  may  be  enforced  in  the  courts.  Substantive 
law  is  divided  into  three  main  classes :  the  law  of  con- 
tracts, the  law  of  property  and  the  law  of  torts.  Prop- 
erty rights  are  not  simple.  There  may  be  dozens  of  con- 
temporary and  dozens  of  sequential  property  rights  in  a 
given  piece  of  wealth.  How  these  rights  are  created, 
maintained  and  transmitted  in  life  and  at  death  is  the 
concern  of  the  law  of  property. 

The  law  of  contracts  deals  not  only  with  such  general 
questions  as  the  creation  of  contracts,  the  parties  to  the 
contract,  the  performance  of  the  contract  and  the  reme- 
dies for  breach,  but  also  with  such  special  forms  of  con- 
tract as  bailments,  insurance,  sales,  guarantees,  bills  and 
notes,  and  the  whole  field  of  business  associations. 

Torts  are  wrongs  committed  by  a  person  against  the 
property  or  person  of  another,  such  as  slander  and  libel, 
negligence,  trespass,  and  conversion  of  property. 

Law  and  equity;  common  law  and  statute  law. — 
Several  further  elemental  facts  about  jurisprudence  must 
engage  our  attention.  Business  men  are  apt  to  pay  too 
little  attention  to  the  making  of  laws.  They  overlook 
the  importance  of  public  opinion  in  forming  the  laws. 
The  tremendous  influence  of  public  opinion  will  be  evi- 
dent to  anyone  who  will  recall  the  gasolineless  Sundays 
that  prevailed  during  the  European  War,  though  no  legis- 
lative enactment  had  been  passed.  Public  opinion  alone 
kept  the  automobiles  off  the  road.  But  laws  not  backed 
up. by  public  opinion  were  unavailing  in  keeping  the  base- 
ball players  off  the  diamonds  on  Sunday  or  in  keeping 
the  doors  of  the  "movie"  theatres  closed. 


6o  PRINCIPLES  OF  BUSINESS 

Public  opinion  becomes  crystallized  in  laws  or  statutes. 
These  may,  as  we  saw  in  our  discussion  of  the  "police 
power,"  affect  every  activity  of  life.  The  common  law, 
based  on  the  early  decisions  of  the  courts,  deals  with  or- 
dinary affairs  such  as  contracts,  but  the  statutes  are 
passed  by  the  legislature  to  amend  the  common  law  when- 
ever the  latter  does  not  meet  the  conditions  of  the  time 
as  the  public  opinion  of  that  time  determines  they  should 
be  met. 

Historically  and  fundamentally  there  is  a  great  differ- 
ence between  law  and  equity.  The  old  law  courts  were 
governed  by  precedent  wherever  there  was  a  precedent 
to  jfit  a  given  case.  The  only  remedy  the  law  courts 
could  give  was  money  damages.  But  there  were  cases 
where  money  could  not  mend  a  wrong.  Prevention  alone 
could  solve  the  difficulty.  No  money  damages  could  re- 
pair, for  example,  the  damage  done  to  decorative  trees, 
centuries  old,  which  were  being  destroyed  by  the  noxious 
fumes  from  a  factory.  In  such  a  case  the  owner  would 
go  to  the  King  and  ask  to  have  the  nuisance  abated.  The 
King  might  directly  command  the  owner  of  the  factory 
to  desist.  It  was  a  personal  order  or  decree  which  must 
be  obeyed  on  pain  of  punishment  by  imprisonment  or 
otherwise.  Afterward  the  King  became  too  busy  to 
attend  to  such  matters  and  referred  them  to  the  Lord 
Chancellor  of  the  Realm,  the  "Keeper  of  the  King's  Con- 
science." Since  the  King's  conscience  was  the  fountain- 
head  of  all  justice,  the  Chancellor  was  not  limited  to 
granting  money  damages.  He,  like  the  King,  could 
order  the  person  to  act  or  not  to  act.  Thus  grew  up  the 
chancery  or  equity  courts  that  act  in  persona }ii,  that  grant 


THE    SOCIAL   SCIENCES  6i 

injunctions,  order  specific  performance  of  contracts  and 
issue  decrees  of  divorce,  appoint  receivers  and  wind  up 
insolvent  estates  involving  an  accounting. 

Experts. — We  have  now  made  a  brief  survey  of  the 
sciences  about  which  the  business  man  should  have  some 
knowledge.  How  far  should  he  go  in  the  pursuit  of  the 
knowledge?  We  recall  the  old  saying  that  certain  busi- 
ness situations  are  so  difficult  that  an  unprejudiced  out- 
sider alone  can  deal  with  them.  Moreover,  the  expert 
does  justify  his  existence  by  knowing  more  about  a 
limited  field  than  the  average  man  in  his  short  lifetime 
can  hope  to  know  if  he  aspires  to  the  same  degree  of 
knowledge  and  skill  in  all  branches. 

The  difficulty  that  has  brought  experts  into  disrepute 
has  been  the  inexpertness  of  many  poseurs — men  who 
through  inaptitude  were  not  fitted  to  master  a  limited 
field,  who  had  not  the  proper  training  and  were  too 
scatter-brained  to  acquire  it.  Not  every  person  who  has 
limited  interests  is  an  expert,  nor  is  a  person  an  expert 
because  he  has  the  "nerve"  to  charge  an  expert's  fee. 

Moreover,  a  person  without  wide  experience  cannot 
be  an  expert,  for  expertness  entails  much  study  of  the 
relation  of  a  given  field  of  study  to  matters  which  at  first 
sight  seem  to  be  quite  unrelated.  An  efficiency  expert — 
so  self-styled — who  knows  all  about  machines  and  records 
may  still  be  a  child  in  swaddHng  clothes  as  far  as  his 
understanding  of  human  nature  is  concerned.  He  is  but 
a  student  and  has  no  right  to  try  to  apply  his  learning. 

What  experts  can  do  for  the  business  man  should  be 
the  constant  study  of  every  serious-minded  business  man. 
To  this  end,  ever}^  man  of  affairs  should  keep  abreast  of 


62  PRINCIPLES  OF  BUSINESS 

the  times  as  progress  is  made  in  the  various  sciences  that 
we  have  included  in  our  so-called  ''environment  of  busi- 
ness." 

BIBLIOGRAPHY 

Graham  Wallas,  The  Great  Society. 

Hobson,  J.  A.,  Work  and  Wealth,  A  Human  Valuation. 

Adams,  Henry  C,  Description  of  Industry. 

Columbia  University,  Lectures  on  Science,  Philosophy  and  Art. 

Callendar,  G.  S.,  Economic  History  of  the  United  States. 

Bogart,  E.  L.,   The  Economic  History  of  the  United  States. 

Coman,  Katharine,  Industrial  History  of  the  United  Siaits. 

Ely,  R.  T.,  Outlines  of  Economics. 

Olga,  F.  A.,  Economic  Development  of  Modern  Europe. 


CHAPTER  V 

THE  SCIENTIFIC  METHOD 

What  is  meant  by  "the  scientific  method." — If  busi- 
ness has  its  science,  business  men  must  be  interested  in 
scientific  method.  Science  is  classified  knowledge,  and 
scientific  method  consists  of  the  production  of  general 
laws  from  classified  facts  and  the  deduction  of  conse- 
quences from  those  laws.  "The  man  who  classifies  facts 
of  any  kind  whatever,  who  sees  their  mutual  relation  and 
describes  their  sequences,  is  applying  the  scientific  metliod 
and  is  a  man  of  science.  The  facts  may  belong  to  the 
past  histor}'  of  mankind,  to  the  social  statistics  of  our 
great  cities,  to  the  atmosphere  of  the  most  distant  stars, 
to  the  digestive  organs  of  a  worm,  or  to  the  life  of  a 
scarcely  visible  bacillus.  It  is  not  facts  themselves  which 
make  science,  but  the  method  by  which  they  are  dealt 
with."^ 

The  man  of  science,  then,  observes  facts,  analyzes  and 
arranges  them,  makes  an  inference  as  to  their  meaning 
and  then  proceeds  to  verify  this  inference.  Let  us  look 
at  these  steps  separately  especially  in  the  light  of  their 
application  to  the  science  of  business. 

The  collection  of  facts. — Facts  may  be  collected  in 
various  ways.  First  there  is  direct  observation.  Accurate 
observation  is  the  first  step  in  scientific  method,  although 
the  scientist  may  skip  this  step  by   using  the  recorded 

^  Karl  Pearson's  The  Grammar  of  Science,  p.  I2. 
63 


64  PRINCIPLES  OF  BUSINESS 

observations  of  other  persons.  In  any  event  it  is  indis- 
pensable that  the  observations  whenever  made  and  by 
whomever  made  be  accurate.  Judges  and  lawyers,  who 
listen  to  the  contradictory  recitals  of  happenings  given 
by  disinterested  witnesses,  know  how  apt  the  human  mind 
is  to  err  in  making  observations.  These  mistakes  may 
be  due  to  poor  observation  or  to  a  total  overlooking  of 
an  object  and  may  result  in  omission  of  elements,  addition 
of  elements,  or  zi^rong  relation  of  the  parts  in  a  whole} 

In  business,  one  of  the  most  frequent  errors  of  obser- 
vation is  that  of  omission.  This  is  due  to  the  fact  that 
the  objects  to  be  observed  are  not  simple  and  are  not 
readily  separable  from  the  other  and  surrounding  ele- 
ments. An  observer  holding  a  stop-watch  while  a  work- 
man performs  a  task  may  not  observe  that  the  machine 
by  which  the  mechanic  is  working  is  being  operated  by  a 
tight  belt  while  all  the  other  belts  in  the  factory  are  some- 
what loose.  A  time  study  made  in  that  way  would  be  of 
little  value.  When  Harriman  in  1901  tried  to  wrest  the 
control  of  the  Northern  Pacific  from  James  J.  Hill  by 
buying  a  majority  of  the  stock  on  the  open  market,  he 
overlooked  the  fact  that  some  of  the  stock  he  was  buying 
was  redeemable 'preferred,  and  that  Hill — who  controlled 
the  board  of  directors  and  had  a  majority  of  the  common 
stock — could  turn  the  preferred  stock  into  money  and 
thus  rob  it  of  its  voting  power.  When  plans  of  business 
action  are  being  formulated,  care  must  be  exercised  to 
make  sure  that  all  essential  facts  have  been  observed  and 
are  included  in  the  subsequent  determination  of  a  policy. 

Prejudice,  as  we  shall  see,  frequently  leads  people  to 

*  Jones,  Logic,  Inductive  and  Deductive,  pp.  x8-ig. 


THE  SCIENTIFIC  METHOD  65 

the  error  of  seeing  what  really  is  not  there.  The  old- 
time  promoter's  crimes  were  partly  to  be  laid  at  the  door 
of  avarice  perhaps,  but  partly  also  at  the  door  of  distorted 
observation  caused  by  self  interest.  A  simple  boring  for 
a  mine,  if  it  showed  metal,  was  considered  sufficient,  and 
the  possibility  of  its  being  misleading  as  to  the  true  quan- 
tity of  metal  was  never  considered.  Fear,  too,  may  cause 
an  exaggerated  observation.  Observation,  it  must  be  re- 
membered, is  a  purely  intellectual,  unemotional  process. 
One  could  hardly  expect  a  frightened  barbarian  to  make 
an  accurate  observation  of  a  steam  locomotive  seen  for 
the  first  time. 

A  very  frequent  source  of  mal-observation  in  business 
is  the  inability  to  see  things  in  their  proper  relation.  Psy- 
chologists are  familiar  with  the  laws  of  illusion.  For 
example,  a  silk  high  hat  looks  considerably  higher  than 
its  width.  The  dimensions  are  usually  equal. ^  Parts 
may  be  so  arranged  as  to  give  an  erroneous  impression  of 
any  single  part.  It  is  said,  for  example,  that  the  general 
massiveness  of  the  head  and  chest  of  Daniel  Webster  led 
many  people  to  overestimate  his  height;  indeed  his  true 
height  was  always  overestimated  till  he  was  measured  for 
his  coffin. 

Causes  of  mal-observation. — Correct  observation  of 
facts  is  so  important  in  business  that  we  may  examine 
some  of  the  chief  causes  of  incorrect  observation  with  a 
view  to  putting  the  earnest  student  on  guard,  (a)  In 
the  first  place,  surrounding  conditions  may  not  be  propi- 
tious for  a  correct  observation.  On  an  unusually  clear 
day  Martha's  Vineyard  seems  very  near  to  the  observer 

1  See  Seashore's  Psxchology  in  Daily  Life,  chap.  vi. 


66  PRINCIPLES  OF  BUSINESS 

who  stands  on  the  shore  of  Cape  Cod,  though  on  an  or- 
dinary day  it  seems  a  full  fifteen  miles  off.  The  pilot 
must  take  atmospheric  conditions  into  account  in  making 
observations  that  come  through  the  sense  of  sight  or 
sound/ 

The  expert  (lay-out  man)  of  the  advertising  agency 
recognizes  this  cause  of  error  when  he  makes  the  red  of  a 
car  card  seem  more  red  by  surrounding  it  with  green,  (b) 
The  observer  may  have  his  senses  impaired  by  physiolog- 
ical infirmity.  The  temporary  infirmities — such,  for  ex- 
ample, as  arise  from  fatigue — are  the  most  dangerous, 
since  they  may  go  unrecognized,  no  allowance,  conse- 
quently, being  made  for  them.  Attention  is  given,  how- 
ever, to  recognized  infirmities,  and  the  observation,  there- 
fore, in  such  a  case,  may  be  made  more  accurately  than  in 
the  case  of  a  supposedly  fit  observer  who  is  unconscious 
of  the  fact  that  his  senses  are  impaired.  It  is  said,  for 
example,  that  the  greatest  number  of  accidents  do  not 
happen  in  factories  at  the  very  end  of  the  day,  for  at  that 
time  the  operators  have  had  their  attention  drawn  to 
their  physical  condition  and  are  more  attentive  to  their 
bodily  welfare.^  On  the  whole,  however,  unusual  physio- 
logical conditions  are  a  handicap  and  interfere  with  accu- 
rate observ^ation.  (c)  We  have  mentioned  the  physical 
and  physiological  impediments  that  may  interfere  with 

1  For  the  distinction  between  sensation  and  perception  or  observa- 
tion, see  James,  Psychology,  chap.  xvii.  Note: — "A  careful  percep- 
tion made  with  a  purpose  is  called  an  observation."    Jones,  Logic, 

p.   22. 

-  Hollingsworth  &  Poffenberger,  Applied  Psychology,  p.  218.  For 
an  extended  study  of  the  "incidence  of  accidents,"  see  Brief  for 
Defendant  in  Error,  in  Butiting  vs.  State  of  Oregon,  reprinted  by 
National  Consumers'  League,  pp.  360-391.  For  the  effects  of  alcohol 
and  tobacco  on  the  brain  and  nervous  system,  see  Fisher  and  Fisk's 
How  to  Live,  pp.  237-239,  263-268. 


THE  SCIENTIFIC  METHOD  67 

accurate  observation.  The  psychological  sources  of 
error,  however,  are  more  important,  because  they  are 
more  frequently  present.  The  more  important  of  these 
sources  of  error  we  shall  enumerate  and  explain  sepa- 
rately. 

( 1 )  Habit.  There  is  always  a  tendency  to  see  things 
as  we  have  seen  them.  Conversely,  if  we  cannot  see 
things  as  we  have  been  in  the  habit  of  seeing  them,  they 
seem  grotesque.  You  might,  for  example,  try  the  simple 
experiment  suggested  by  James  {Psychology,  vol.  11.,  p. 
81),  of  lying  on  your  back  and  looking  up  at  a  person 
talking  who  stands  behind  you.  The  lower  lip  is  seen 
in  such  an  unusual  way  that  it  "seems  animated  by  the 
most  extraordinary  and  unnatural  mobility."  It  is  pre- 
cisely for  this  reason  that  the  so-called  expert  makes  claim 
for  ability  to  see  things  in  a  business  that  the  proprietor 
or  manager,  habituated  to  its  methods,  cannot  clearly 
recognize. 

To  habit,  probably  are  to  be  attributed  many  of  the  ob- 
stacles that  are  put  in  the  way  of  business  progress.  The 
survival  of  the  idea  of  craft  organization  of  labor,  pre- 
venting as  it  does  the  grouping  of  workers  in  a  scientific 
way — on  a  basis  of  efficiency  and  ability — is  one  of  the 
obstacles  to  the  growth  of  scientific  management. 

(2)  Prejudice.  We  tend  to  observe  what  we  expect  or 
hope  to  see.  Prejudice  varies  all  the  way  from  mere 
neglect  or  carelessness  to  a  positive  though  perhaps  some- 
what unconscious  determination  to  slight  the  facts.  To 
this  psychological  infirmity  must  be  attributed,  for  ex- 
ample, the  charter  of  Aaron  Burr's  Manhattan  Company. 

^  See  Tkompson's  The  Theory  and  Practice  of  Scientific  Man- 
agement, pp.   150-151. 


68  PRINCIPLES  OF  BUSINESS 

The  legislature  was  expecting  a  bill  for  the  establishment 
of  a  water  company;  they  did  not  observe  a  clause,  sand- 
wiched in,  giving  the  company  the  right  to  do  a  banking 
business,  under  which  right  the  Bank  of  the  Manhattan 
Company  is  still  doing  business  in  New  York  City.  Prej- 
udice lies  at  the  root  of  many  business  problems.  It  is 
natural,  perhaps,  that  a  person  who  has  been  handling  a 
business  for  a  long  time  should  believe  he  knows  all 
about  it.  This  prejudice  in  favor  of  self  is  a  frequent 
cause  of  non-observation. 

3.  Lack  of  attention  or  misplaced  attention.  The 
cheating  huckster  for  example,  trades  on  this  infirmity 
when  he  displays  a  sign,  "Malaga  Grapes  5  cents  a  ^- 
pound."  The  average  person  asks  for  a  pound  and 
then  gets  change  for  a  ten-cent  purchase.  His  attention 
is  centered  on  the  "five  cents"  and  on  the  "pound,"  and 
he  fails  to  see  the  ">4." 

4.  Lack  of  training.  The  man  about  the  street  may 
look  at  a  dog  for  five  minutes  and  then  be  able  to  tell 
little  more  about  it  than  its  breed,  general  size  and  color. 
The  dog-fancier  after  a  moment's  glance  could  tell  many 
details.  He  has  trained  himself  to  observe  the  shape  of 
the  head,  the  set  of  the  ears,  the  shape  of  the  legs,  the 
stance,  and  the  angle  of  the  tail.  Dry-goods  houses  em- 
ploy expert  buyers  in  their  several  departments — people 
who  are  trained  to  observe  details  that  the  average  person 
might  overlook.  Here  again  the  expert  with  much  ex- 
perience in  a  limited  field  has  advantage  over  the  slightly- 
experienced  general  practitioner. 

5.  Abnormal  psychological  conditions.  Seashore,  in 
his  Psychology  of  Every-day  Life,  tells  this  story   (p. 


THE  SCIENTIFIC  METHOD  69 

185)  :  "In  demonstrating  an  illusion  in  sight  to  a  class 
one  day,  the  lecturer  said :  'You  observe  that  this  line, 
which  is  actually  straight,  looks  bent.'  All  the  class  ex- 
cept one  young  man,  verified  the  observation.  He  said, 
'It  looks  straight  to  me.'  Then  presenting  the  comple- 
mentary phase  of  the  illusion,  the  lecturer  said :  'You  ob- 
serve that  this  line,  which  is  actually  bent,  looks  straight.' 
All  agreed  except  the  same  young  man.  He  said,  'That 
line  looks  bent  to  me.'  The  lecturer  thereupon  made 
closer  observation  and  found  that  the  young  man  was 
drunk,  and  reported  him  to  the  president,  with  the  re- 
sult that  he  was  expelled  from  the  university  within  two 
hours  from  the  time  that  he  proved  refractory  to  a  normal 
illusion."  ^ 

Testing  observations. — The  trained  scientist  holds 
every  observation  "in  suspicion  until  tested."  Here,  per- 
haps, is  the  greatest  difficulty  of  the  business  scientist  or 
the  social  scientist.  He  cannot  test  his  observations  with 
the  same  facility  as  does  the  physicist  or  the  chemist.  The 
marketing  man  of  a  business  prepares  a  selling  letter  and 
sends  it  to  5,000  people  in  different  parts  of  the  country. 
He  may  get  a  3  or  4  per  cent  return,  and  on  the  strength 
of  this  mail  out  100,000  additional  letters.     The  second 

^  I  am  reminded  by  this  story  of  the  experience  I  am  told  young 
men  have  had  who  have  apphed  for  admission  to  the  aviation  corps. 
They  are  strapped  in  a  chair  which  is  whirled  around.  When  the 
chair  is  stopped  the  candidate  involuntarily  lists  to  one  side.  He 
usually  fears  that  his  chances  are  gone  and  makes  a  desperate  at- 
tempt to  put  himself  on  "even  keel,"  when  he  is  assured  that  his  list 
to  one  side  is  all  that  saves  him.  It  is  a  normal  tendency  and  is  of 
great  service  in  making  the  candidate  an  eliticient  flier.  Men  who  do 
not  "list"  are  rejected.  This,  to  be  sure,  has  nothing  to  do  with 
observation,  but  does  illustrate  psychological  and  physiological  in- 
firmities that  may  interfere  with  the  normal  working  of  the  sensory 
organs  through  which  observations  are  made. 


70  PRINCIPLES  OF  BUSINESS 

batch,  however,  may  be  delivered  to  readers  on  a  rainy 
day,  while  the  test  letter,  perhaps,  was  received  on  a 
clear  day.  The  return  on  the  100,000  issue  may  be  much 
more  or  less  than  on  the  first  issue,  for  the  correspondents 
may  be  in  a  different  mood  on  account  of  the  weather. 
Or,  perhaps,  some  important  news  in  the  morning  paper 
may  put  people  in  a  different  frame  of  mind.  Or,  per- 
haps, the  second  batch  may  be  delivered  on  Monday — 
with  a  day  and  a  half's  accumulation  of  other  mail — 
whereas  the  earlier  issue  may  have  been  delivered  on 
Wednesday  or  Thursday. 

The  simplest  way  to  test  an  observation  is  by  experi- 
ment ;  but  experiment,  to  be  worth  anything,  must  be  per- 
formed under  constant  or  controlled  conditions.  In 
chemistry,  for  example,  we  can  experiment  successfully, 
for  we  can  isolate  our  facts,  by  placing  our  chemicals  in 
a  test  tube. 

So  important  is  this  matter  to  the  scientist  who  studies 
business  that  we  may  be  excused  for  explaining  the  situa- 
tion at  length.  If  this  inherent  difficulty  of  the  science 
of  business — the  inability  of  the  practitioner  to  carry  on 
scientific  experiments — were  understood  by  the  so-called 
practical  man,  a  great  deal  of  his  complaint  about 
''theory"  and  "theorists"  would  be  dissolved  and  he  prob- 
ably would  be  more  appreciative  of  the  "theorist's" 
efforts. 

The  method  of  the  physicist  or  the  chemist  working  in 
his  laboratory  may  be  described  in  the  words  of  Lotze^ : 
"Whenever  we  can,  by  our  own  agency,  influence  the 
object  we  are  investigating,  we  can  remedy  this  want 

1  Lotze's  Logic,  Bk.  11,  chap,  vii,  260,  quoted  in  the  text  from 
Jones's  Logic,  p.  25. 


THE  SCIENTIFIC  METHOD  71 

(insufBcient  observation)  by  experiment.  We  can  insti- 
tute at  will  a  certain  group  of  conditions  C,  and  so  compel 
the. causes  which  are  really  at  work  to  respond  with  an 
effect  E,  which  would  otherwise  perhaps  have  never  come 
within  the  domain  of  our  senses.  By  varying  at  will  the 
quantity  and  composition  of  that  C  we  can  bring  about 
in  E  a  series  of  changes  in  quantity  and  kind,  which  were 
still  less  likely  to  offer  themselves  unsolicited  to  our  ob- 
servation. Again,  we  can  break  up  C  into  component 
parts,  and  in  each  experiment  allow  but  one  of  these,  or 
a  definitely  assigned  group  of  several  of  them  to  take 
effect,  at  the  same  time  cutting  off  the  rest  from  action. 
The  constituent  elements  of  tlie  result  E  admit  of  being 
separated  in  the  same  way,  so  that  we  learn  which  of  them 
depends  upon  which  element  of  the  compound  C.  Thus 
experiment  is  the  practical  means  by  which  we  furnish 
ourselves  with  observations  in  such  number  and  involving 
such  mutual  differences  and  affinities  as  are  requisite  to 
eliminate  what  is  unessential  in  them." 

The  conditions  under  which  experiments  may  be  con- 
ducted, described  in  the  above  paragraph,  are  ideal.  When 
you  introduce  the  human  element,  you  immediately  elim- 
inate the  possibility  of  having  constant  working  condi- 
tions. 

God's  most  dreaded  instrument, 

In  working  out  a  pure  intent, 

Is  MAN. 

The  modern  social  economist  recognizes  this  situation. 

"The  facts  of  human  nature  which  are  of  the  greatest 

importance  to  the  social  psychologist  are  just  those  to 

which    laboratory   methods   are    least    applicable.     It   is 


72  PRINCIPLES  OF  BUSINESS 

almost  impossible  to  arrange  a  series  of  identical  experi- 
ments to  illustrate  the  working  of  patriotism  or  ambition 
or  the  property  instinct  or  artistic  and  intellectual  crea- 
tiveness.  In  such  matters  the  social  psychologist  must  be 
content  with  the  instances  which  arise  in  ordinary  life, 
and  must  examine  them  by  the  older  methods  of  intro- 
spection, personal  evidence,  and  analogy."  ^ 

DifEculties  of  experimenting  with  complex  facts. — 
Before  proceeding  to  a  more  detailed  discussion  of  this 
one  illusive  element  that  goes  into  the  business  scientist's 
test  tube,  we  must  pause  to  consider  another  difficulty  in 
the  way  of  accurate  observation  and  scientific  experimen- 
tation, namely,  the  complexity  of  business  situations. 
This  complexity  of  even  the  most  trivial  problems  is  sufifi- 
cient  to  thwart  the  efforts  of  the  very  best  trained  and 
most  competent  reasoners.  To  appreciate  how  almost 
hopeless  the  problem  is,  we  must  draw  a  lesson  from  one 
of  the  most  exact  of  sciences,  astronomy.  "In  its  most 
general  form,  the  'problem  of  three  bodies'  is  insoluble  by 
any  mathematical  processes  that  have  yet  been  invented; 
in  other  words,  if  only  the  three  bodies,  the  sun,  the  moon, 
and  the  earth  existed,  it  would  still  be  impossible  to  obtain 
a  solution  of  the  problem — what  will  be  the  motions  of 
these  three  bodies  under  the  influence  of  their  mutual 
attractions."^  If  the  difficulty  is  so  great  here — not  in- 
superable, since  mathematics  is  helped  out  by  other  sci- 
ences— what  must  the  task  of  the  business  scientist  be 
who  has  a  multitude  of  forces  and  facts  to  bring  together 
for  observation  ? 

It  is  for  this  reason  as  well  as  for  the  reason  that  one 

1  Graham  Wallas,  The  Great  Society,  p.  30. 

2  Hink's  Astronomv.  pp.  125-126  (Home  University  Library). 


THE  SCIENTIFIC  METHOD  73 

of  the  facts  itself — man — is  complex,  that  economists 
have  such  difficulty  in  working  out  a  social  science  of 
business.  "If  a  science  at  all  (political  economy),  must 
be  a  mathematical  science,  because  it  deals  with  quantities 
of  commodities.  But  as  soon  as  we  attempt  to  draw  out 
the  equations  expressing  the  laws  of  demand  and  supply, 
we  discover  that  they  have  a  complexity  entirely  surpass- 
ing our  power  of  mathematical  treatment.  We  may  lay 
down  the  general  form  of  equations,  expressing  tlie  de- 
mand and  supply  for  two  or  three  commodities,  among 
two  or  three  trading  bodies,  but  all  the  functions  involved 
are  so  complicated  in  character  that  there  is  not  much 
fear  of  scientific  method  making  rapid  progress  in  this 
direction."  ^ 

Importance  of  the  human  element  in  business. — 
The  old  economists  tried  to  solve  the  problems  of  eco- 
nomics by  reasoning  about  a  "standard"  man  on  a  lonely 
isle — old  Robinson  Crusoe  was  constantly  being  made  to 
do  duty  for  this  purpose.  Alas,  there  is  no  standard 
man.  Nor  can  there  be.  I  happened  to  come  upon  a 
leading  farm  journal  the  other  day  and  in  it  I  read  a  bit 
of  advice  to  farmers  on  how  to  slaughter  hogs  and  what 
to  do  with  their  decapitated  heads.  I  could  not  restrain 
a  smile  at  the  thought  of  what  a  different  individual  I 
should  be  if  a  part  of  my  work  consisted  of  slicing  off 
ears,  gouging  out  eyes,  slitting  up  jaws  and  dislocating 
hogs'  brains.  Mind  you,  I  claim  no  superiority — but  I 
do  feel  that  I  probably  should  have  a  different  outlook  on 
everything  in  life  if  I  had  had  these  experiences.  The 
myriad  influences  of  heritage  and  environment  that  make 

1  Jevons,  The  Principles  of  Science,  pp.  759-60. 


74  PRINCIPLES  OF  BUSINESS 

up  man  can  be  combined  in  an  infinite  number  of  ways, 
and  hence  we  have  an  infinite  variety  of  men.  There  is 
no  Robinson  Crusoe.  Each  man  has  his  own  Robinson 
Crusoe  who  differs  from  his  neighbor's  Crusoe  as  he 
himself  differs  from  his  neighbor. 

Unfortunately  for  the  business  scientist,  this  most  elu- 
sive element,  man,  is  the  most  important  element  that 
must  go  into  his  test  tube  of  experimentation.  The  chain 
of  reasoning  on  any  subject — be  it  selling  policy,  produc- 
tion policy,  or  socialism — that  leaves  man  out  of  the 
reckoning  is  worthless.  I  am  reminded  of  the  impor- 
tance given  to  this  subject  by  the  late  Colonel  Maude  in 
his  article  on  "Strategy"  in  the  Encyclopedia  Britannica. 
He  says :  "In  conclusion,  the  man  who  would  fit  himself 
for  the  highest  commands  in  war,  or  even  for  the  criticism 
of  those  who  exercise  them,  must  never  for  one  moment 
forget  that  the  momentary  spirit  of  the  mass  he  directs 
is  the  fundamental  condition  of  the  success  of  every 
movement.  Just  as  there  is  no  movement  so  simple  that 
its  success  may  not  be  jeopardized  by  ill-will  and  despond- 
ency in  execution,  there  is  hardly  any  limit  to  what  willing 
men  can  achieve,  and  it  has  been  this  power  of  evoking 
in  their  commands  the  spirit  of  blind  trust  and  confidence 
that  places  men  like  Cromwell,  Marlborough,  Frederick 
and  Napoleon  almost  beyond  reproach.  By  the  side  of 
this  power  the  technical  knowledge  and  ingenuity  dis- 
played in  their  several  undertakings  appear  quite  trivial ; 
probably  the  same  ideas  have  occurred  to  thousands  of 
quite  mediocre  men,  but  never  put  into  execution,  because 
they  could  not  count  on  the  whole-souled  devotion  of 
their  men  to  execute  them." 


THE  SCIENTIFIC  METHOD  75 

In  any  form  of  experimentation  in  business,  then,  the 
one  most  important  element  to  be  observed  generally  is 
the  human  element.  It  goes  without  saying  that  in  such 
experimentation  the  men  who  make  up  the  human  element 
must  be  living  in  a  not  unusual  atmosphere.  A  chemist 
would  not  expect  to  get  normal  results  in  his  experiments 
if  he  conducted  them  in  an  icebox  or  at  the  north  pole. 
Unfortunately  some  business  investigators  surround 
themselves  with  a  frigid  atmosphere  and  then  expect  their 
experiments  to  show  normal  results.  One  of  the  leading 
exponents  of  scientific  management  for  example,  admits 
this  shortcoming  of  some  of  the  workers  in  his  field  by 
reprinting  this  story  from  a  general  criticism  of  efficiency 
men:  "A  number  of  years  ago  one  of  the  now  leading 
efficiency  engineers  was  engaged  in  a  large  industrial 
plant  to  introduce  a  piece-work  system.  For  two  years 
he  labored;  stop-watch  in  hand,  he  timed  the  various 
operations  and  tabulated  the  results.  His  attitude  toward 
the  workmen  was  impersonal.  He  was  a  scientist  (?)^ 
in  his  laboratory.  He  was  a  man  apart.  The  men 
around  him  recognized  him  as  such.  Lacking  their  con- 
fidence, co-operation  was  impossible.  When  he  appeared 
in  the  shop  and  began  his  observations,  machines  would 
often  be  slowed  down,  with  loss  of  output,  or  speeded 
up,  with  damage  to  tools.  Every  device  known  to  the 
various  trades  was  resorted  to  to  block  him  at  each  turn. 
The  result  was  that  after  two  years  of  effort  the  estab- 
lishment of  a  satisfactory  piece-work  system  was  as  far 
from  realization  as  it  had  been  when  the  task  was  started. 
Then  a  practical  man  was  called  in.    He  acquainted  him- 

1  The  interrogation  point  is  in  the  original. 


-jd  PRINCIPLES  OF  BUSINESS 

self  with  the  machines  and  their  capacity.  He  mingled  . 
with  the  men  and  gained  their  confidence.  He  explained 
that  the  object  in  view  was  two-fold,  to  increase  the  out- 
put at  a  reduced  cost  per  unit  to  the  company,  and  at  the 
same  time  to  enable  the  men  to  earn  more.  Within  six 
months  he  had  accomplished  results  that  the  efficiency 
man  had  spent  two  years  in  an  effort  to  secure.  Why? 
Because  he  appreciated  the  importance  of  the  man  ele- 
ment." ^ 

Progress  of  experimentation  in  business. — The  busi- 
ness scientist  need  not  despair  because  his  task  is  more 
difficult  than  that  of  men  working  in  the  fields  of  the 
natural  or  physical  sciences.  Let  him,  simply,  first  have 
a  realizing  sense  of  the  inherent  difficulties  of  his  under- 
taking and  then  let  him  make  no  claims  for  his  work  be- 

1  Thompson's  Scientific  Management,  p.  619.  That  this  criticism 
does  not  apply  to  the  more  proficient  and  capable  efficiency  engi- 
neers will  be  seen  from  the  following  account  of  their  work  by  one 
of  the  best  known,  H.  L.  Gantt :  "Although  slide  rules  for  determin- 
ing how  to  do  machine  work  and  instruction  cards  for  directing  the 
workmen  had  been  in  use  since  May,  1899,  the  monthly  output  of 
the  shop  (of  the  Bethlehem  Steel  Company)  during  the  year  from 
March  i,  1899  to  March  i,  1901,  had  been  but  little  more  than  the 
monthly  average  for  the  five  years  preceding. 

"Up  to  this  time  we  had  devoted  our  eiiforts  principally  to  the 
study  of  what  could  be  done,  and  had  done  but  little  to  cause  the 
workmen  to  co-operate  with  us.  This  record  shows  that  we  had  not 
in  any  measurable  degree  secured  their  co-operation.  In  other 
words,  we  had  much  knowledge,  but  were  unable  to  get  any  sub- 
stantial benefit  from  it  because  the  men  would  not  help.  On  March 
I  J,  1901,  I  suggested  that  we  pay  a  bonus  of  50  cents  to  each  work- 
man who  did  in  any  day  all  the  work  called  for  in  his  instruction 
cards.  *  *  *  We  must  secure  the  confidence  and  co-operation  of  the 
workman  by  assuring  him  equitable  compensation.  *  *  *  The  task 
with  a  reward  for  its  accomplishment  produces  this  interest  (which 
saves  the  workman  from  forcing  himself  to  do  the  work)  and  holds 
the  attention,  with  the  invariable  results  of  more  work,  better  work 
and  better  satisfied  workers."  (From  a  paper  read  by  H.  L.  Gantt, 
at  the  Eleventh  Annual  Meeting  of  the  National  Civic  Federation, 
January  12-14,  191 1.) 


THE   SCIENTIFIC  METHOD  77 

yond  tlie  bounds  of  possible  accomplishment.  The  fact 
is  that,  with  all  its  difficulties,  experimentation  is  making 
some  progress  in  the  science  of  business.  In  spite  of  all 
the  gibes  against  the  efficiency  man,  he  has  found  his  place 
in  the  sun  and  has  had  made  notable  progress  in  the 
installation  of  his  system  in  industrials,  railroads  and 
public  institutions. 

And  the  publications  of  certain  psychologists  show  that 
not  only  are  experiments  with  man  in  industry  and  com- 
merce being  conducted  in  a  scientific  spirit,  but  that  they 
are  yielding  results.  What  is  the  best  copy  for  advertise- 
ments ;  what  is  the  best  advertising  position  on  the  double 
page  of  a  magazine ;  what  is  the  effect  of  fatigue  on  the 
operator;  what  are  the  least  fatiguing  ways  of  perform- 
ing a  given  operation;  what  is  the  effect  of  fatigue  on 
color  sense;  what  type  is  most  easy  to  read  and  at  the 
same  time  most  economical  of  space? — these  are  but  a 
few  of  the  problems  that  are  being  solved  by  experinjent 
carried  on  by  making  observation  of  the  effects  of  vari- 
ously combined  elements.  The  field  for  the  scientist  in 
business  is  limitless,  even  if  the  results  cannot  always  be 
definite.- 

Moreover,  it  is  probably  true  that  some  of  the  difficul- 
ties already  mentioned  are  tending  to  disappear  while 
our  ability  to  handle  the  other  difficulties  is  increasing. 
The  elimination  of  human  labor  in  many  industrial  proc- 
esses makes  possible  standardization  in  production,  and 

'  See  Thompson's  The  Theory  and  Practice  of  Scientific  Man- 
agement, pp.  36-75- 

2  See  Miinsterberg's  Psychology  and  Industrial  Efficiency;  Hol- 
lingsworth  and  Poffenberger's  Applied  Psychology ;  Hollingsworth's 
Advertising  and  Selling,  and  several  of  the  essays  in  Copeland's 
Business  Statistics. 


78  PRINCIPLES  OF  BUSINESS 

the  development  of  the  esthetic  tastes  of  the  masses  will 
result  in  making  possible  the  simplification  of  marketing 
processes.  That  a  long  way  has  still  to  be  travelled  to 
accomplish  much  in  the  latter  direction  is  evident  to  any- 
one who  sees  the  so-called  "funny  pages''  in  our  Sunday 
papers  or  who  visits  the  lamp  or  picture  departments  of 
an  installment  furniture  house. 

Memory. — In  the  previous  paragraphs  we  discussed 
the  collection  of  facts  through  the  direct  means  of  obser- 
vation. Let  us  now  turn  our  attention  to  various  indirect 
means  of  getting  knowledge.  As  I  write  this  book,  part 
of  my  raw  material  is  obtained  through  search  and  re- 
search into  the  testimony  of  others,  part  from  the  memory 
of  past  research,  and  part  from  the  memory  of  past 
observation. 

In  modern  business,  of  course,  memory  is  largely 
supplemented  by  records.  It  is  perhaps  not  too  much  to 
say .  that  modern  large-scale  production  and  modern 
accounting  go  hand  in  hand.  One  has  supported  and  re- 
ceived support  from  the  other.  Of  this  we  shall  say  more 
later.  But  at  present  we  may  venture  a  few  words  on  the 
subject  of  the  memory.  A  memory  test  is  a  very  fair  test 
of  ability  of  an  individual,  since  he  who  has  a  poor  mem- 
ory is  apt  to  be  a  poor  or  heedless  observer  and  an  in- 
differently poor  thinker.  The  way  to  improve  the  mem- 
ory is  by  improving  the  method  of  noticing  things  and 
by  increasing  the  amount  of  thinking  with  which  the 
noticing  is  mixed  up.  One  man  starts  out  to  learn 
a  selling-talk;  he  tries,  parrot-fashion,  to  memorize 
sentence  after  sentence.  He  may  consume  days  in  the 
process  and  then  never  be  quite  sure  of  himself.     An- 


THE  SCIENTIFIC  METHOD  79 

other  man  will  begin  by  analyzing  his  talk  into  its  main 
points.  Each  point  will  then  be  studied  in  a  logical  way 
- — sentences  as  such  will  come  last.  Such  a  man  will  "get 
his  talk  down  pat"  in  a  surprisingly  short  time.^  One 
way  to  improve  the  memory  is  to  describe  as  carefully  as 
possible  the  things  we  observe  or  experience,  and  to  dis- 
cuss them.  Conservation  not  only  teaches  us  new  things 
but  helps  us  to  remember  those  we  already  know.^ 
"Growth  through  self-expression"  is  a  prime  law  of  men- 
tal efficiency. 

Testimony. — Two  methods  of  acquiring  knowledge 
thus  far  described  are  observation  and  the  use  of  the 
memory.  A  third  method  is  testimony.  Fortunately 
for  the  business  man,  testimony  is  becoming  an  ever-in- 
creasingly  abundant  source  of  business  information.  Ten 
years  ago,  there  were  few  books  indeed  on  business. 
Economic  theory  occupied  the  attention  of  students  much 
more  than  the  facts  of  business.  Where  then  one  or  two 
books  appeared,  now  they  are  being  written  and  published 
by  the  hundreds.  Some  of  the  more  important  of  these 
publications  are  listed  in  the  bibliographies  at  the  end  of 
each  chapter  of  this  book. 

Importance  of  reading  by  pages. — The  literature  of 
business  is  becoming  so  vast  that  it  behooves  the  average 
man  to  train  himself  to  read  rapidly.  Men  like  Macaulay 
and  Roosevelt,  who  seem  to  have  limitless  interests  and 

^  For  a  similar  experience  in  memorizing  sermons,  see  James, 
Psychology,  p.  667. 

2  Teachers  and  students  in  so-called  "Business  Colleges"  will  be 
interested  in  the  commendation  of  their  work  in  this  respect  by 
Professor  Seashore  in  his  Psychology  in  Daily  Life.  p.  81.  Pro- 
fessor Seashore's  chapter  on  "Serviceable  Memory,"  Ibid.,  chap.  11, 
is  delightful  reading  and  contains  perhaps  all  that  can  be  said  to 
the  average  man  on  the  subject. 


8o  PRINCIPLES  OF  BUSINESS 

limitless  information,  have  gotten  tlieir  facts  by  reading 
a  page  at  a  time  and  turning  over  the  pages  as  one  would 
turn  them  leisurely  in  a  family  album  of  unknown  and 
unstriking  photographs.  The  novice  must  not  think  this 
a  step  to  be  taken  at  once.  Quick  reading  follows  from 
previous  slow  thinking.  All  of  our  new  experiences  are 
limited  by  our  old  experiences.  We  tack  them  on  to  what 
already  has  happened.  The  student,  then,  should  begin 
slowly  by  arranging  his  information,  classifying  and 
labelling  it,  and  then  storing  it  away.  Afterward,  when 
he  begins  to  read  faster,  he  will  find  the  pigeon-holes  of 
his  mind  ready  to  receive  the  new  information.  Pages 
of  a  book  at  a  time  can  then  be  enveloped  with  the  eye, 
for  the  contents  will  merely  drop  into  the  appropriate 
compartments  of  the  mind,  and  only  the  new  will  have  to 
be  accommodated.  Macaulay  read  the  Bible  through  at 
the  age  of  four;  Roosevelt  at  the  age  of  twenty-two  had 
written  one  of  the  best  histories  of  a  short  period  of  this 
country  that  has  been  produced.  These  men  began  early, 
with  much  reading  and  clear  thinking,  to  provide  the  re- 
ceptacles for  new  mental  experiences. 

Testimony  in  modern  business  education. — Modem 
education  uses  both  observation  and  testimony  as  a  means 
of  conveying  useful  information.  This  is  true  now  of 
business  education  as  well  as  of  general  or  other  technical 
education.  Nowadays,  the  medical  student  performs  his 
chemical  laboratory  experiments  and  dissects  cadavers. 
But  he  does  all  this  in  a  school  where  the  greater  part  of 
his  education  is  acquired  from  books  and  lectures.  His 
education  now  is  largely  a  matter  of  testimony.  In  days 
gone  by,  most  of  his  education  came  as  a  result  of  scat- 


THE  SCIENTIFIC  METHOD  8i 

tered  experiences.  As  late  as  1721  there  was  but  one 
physician  in  Boston  whose  training  had  been  of  the  school 
rather  than  in  the  apprenticeship  system.  The  same  con- 
dition existed  in  the  legal  profession.  It  was  not  until 
the  opening  of  the  nineteenth  century  that  the  young 
lawyer  regularly  got  his  information  from  the  organized 
testimony  furnished  through  the  teaching  of  law  schools. 
It  is  said  that  Patrick  Henry  was  admitted  to  the  bar  of 
Virginia  on  the  motion  of  Thomas  Jefferson  after  only 
two  or  three  weeks  of  study.  The  rest  of  his  legal  educa- 
tion was  obtained  evidently  by  experimenting  at  the  ex- 
pense of  his  chents. 

The  business  student,  of  course,  observes  as  well  as 
reads.  Today,  however,  so  vast  is  the  amount  of  infor- 
mation that  must  be  acquired,  that  testimony — as  com- 
pared with  direct  observation — has  become  of  relatively 
greater  importance  than  it  was  under  the  old  apprentice- 
ship method  of  business  education.  "In  the  good  old 
days,  the  artisan  learned  his  craft  or  trade  by  working 
alongside  of  the  master  and  absorbing  not  only  the  mas- 
ter's handicraft,  but  all  his  worldly  wisdom,  his  ethical 
and  religious  standards.  It  is  impossible  for  a  workman 
to  learn  his  trade  or  occupation  in  that  way  today,  and, 
thank  God,  we  have  begun  to  realize  that  the  task  here- 
tofore performed  by  the  master-workman  who  was  a 
workman  himself,  must  be  transferred  to  the  schools."  ^ 

Making  inferences. — After  facts  have  been  collected, 
analyzed  and  classified,  the  next  step  is  to  find  the  laws 
governing  the  facts.     This  is  done  by  formulating  a  ten- 

1  Prof.  John  H.  Gray,  "Professional  Accountancy  and  Education," 
Journal  of  Accountancy,  vol.  II,  p.  123. 


82  PRINCIPLES  OF  BUSINESS 

tative  law,  or  inference,  or  hypothesis,  and  then  verifying 
it.  The  formulation  of  such  laws  and  their  verification 
complete  the  scientific  inductive  process.  Perhaps 
"practical"  men  Avill  not  be  interested  in  how  the  laws 
are  made,  but  will  be  interested  only  in  whether  they  are 
true  and  how  they  can  be  used.  This  is  a  not  unfair  atti- 
tude for  the  business  man  to  take  who  is  actually  well 
along  with  the  conduct  of  his  business.  He  will  let  the 
discovery  of  the  laws  go  to  experts.  But  this  attitude 
should  not  cause  him  to  despise  or  neglect  the  work  of  the 
experts.  Indeed  he  should  (and  the  more  successful  do) 
encourage  experts  to  use  their  scientific  methods  for  the 
advancement  of  his  ends.^     Dozens  of  institutions,  such 

1  The  crux  of  the  whole  matter  is,  we  believe,  as  is  pointed  out 
in  the  text,  that  induction  is  the  proper  domain  of  the  expert,  the 
university  man  and  the  research  specialist ;  whereas  the  business- 
man's domain  is  that  of  deduction  or  the  use  of  the  laws  of  busi- 
ness discovered  by  the  s-pecialist.  Professor  Jones  has  developed 
the  idea  at  length  in  his  Business  Administration.  "The  scientific 
point  of  view  is  to  follow  the  lead  of  the  subject-matter.  This 
means  that  when  the  aim  of  any  piece  of  work  is  complete  knowl- 
edge of  a  given  subject,  it  is  not  intelligent  to  complicate  the  prob- 
lem by  adding  the  question  of  the  use  to  which  the  knowledge  is 
to  be  put  after  it  is  attained.  This  is  simply  following  the  rule 
of  having  a  properly  circumscribed  aim — a  practice  the  value  of 
which  all  administrators  understand. 

"On  the  other  hand,  the  practical  problem  begins  by  setting  a 
specific  goal,  such  as  a  desired  substance  or  process.  It  inquires 
as  to  the  most  expeditious  means  of  attaining  this  result.  In  such 
a  case,  to  investigate  those  aspects  of  things  which  obviously  have 
no  connection  with  the  problem,  on  the  ground  that  the  S'tock  of 
human  knowledge  will  be  increased  by  so  doing,  is  to  forget  what 
one  is  about.  The  scientist  and  the  practical  man  both  give  them- 
selves immense  credit  for  following  precisely  the  same  rule, — that  of 
the  division  of  labor. 

"To  the  'practical'  man,  the  scientist  incubates  ineflficiently  be- 
cause he  does  not  check  up  vigorously  enough  with  himself.  And 
this  arises  from  his  hazy  philosophy  of  not  knowing  exactly  what 
he  wants,  or  the  probable  value  of  it  all.  The  scientist  sometimes 
gives  an  unjustifiable  extension  to  the  rule  of  his  work  which  is 
expressed  by  the  phrases :  'Truth  for  Truth's  Sake,'  and  'Art  for 
Art's  Sake.'     This  is  a  minor  rule  of  thinking,  essential  within  its 


THE  SCIENTIFIC  METHOD  83 

as  the  Curtis  Publishing  Company  and  the  National  Suit 
and  Cloak  Company,  use  the  services  of  experts  who  have 
given  time  and  effort  to  the  discovery  of  the  laws  of  men- 
tal efficiency.^  Indeed,  our  most  successful  men  like  Car- 
negie and  Rockefeller,  after  a  life  of  business  struggle,, 
testify  to  the  value  of  business  research  by  founding,  and 
maintaining  institutions  in  which  experts  can  carry  on 
their  investigations. 

However,  young  men  preparing  for  business  should 
study  the  methods  of  the  scientist  that  they  may  learn 
the  laws,  remember  them,  and  understand  how  to  apply 
them.  Consciously  or  unconsciously,  men  are  constantly 
applying  laws,  though,  as  we  shall  see,  many  of  them  are 
faulty — the  results  of  ''snap  judgment"  without  ade- 
quate verification  or  checking  up. 

Verification. — An  inference  does  not  rise  to  the  dig- 
nity of  a  law  till  it  has  been  verified.  In  the  hurry  and 
bustle  of  modern  business  we  are  apt  to  accept  conclusions 
without  amply  testing  them."     Mere  reasoning  will  not 

proper  sphere,  but  it  is  limited  in  validity  and  in  appropriate  applica- 
tion by  the  force  of  the  greater  rule  of  life, — Truth  and  Art  for 
Man's  Sake. 

"To  the  scientist,  the  'practical'  man  does  not  even  know  the  wide 
range  of  the  practical.  By  impatiently  applying  to  intermediate  pro- 
ductive steps  the  tests  which  are  appropriate  only  for  final  results, 
he  cuts  himself  off  from  many  indirect  but  highly  profitable  chains 
of  productive  effort.  That  science  and  practice  are  different  is 
not  a  reason  for  antagonism,  but  for  co-operation.  Each  may 
exercise  a  corrective  influence  upon  the  other.  'We  may  hope,' 
said  Huxley,  'that,  at  last,  the  weary  misunderstanding  between  the 
practical  men,  who  professed  to  despise  science,  and  the  high  and 
dry  philosophers,  who  professed  to  despise  practical  results,  is  at 
an  end.' " 

1  See  Kemble's  Choosing  Employees  by  Mental  and  Physical 
Tests. 

2  A  word  should  be  said  here  about  the  difference  between  mak- 
ing decisions  and  coming  to  conclusions.  It  is  true  that  in  business 
occasions  arise  when  decisions  must  be  made  quickly.    Not  to  make 


84  PRINCIPLES  OF  BUSINESS 

do.  The  inference  or  law  itself,  as  an  approximation  of 
what  is  probably  true  about  the  facts  collected  and  classi- 
fied, is  a  matter  of  inspiration  or  imagination.  The  veri- 
fication is  a  matter  of  hard  and  patient  work.  Karl  Pear- 
son illustrates  the  proper  method  by  telling  how  Darwin 
wrote  his  Origin  of  Species.^ 

a  decision  promptly  is  perhaps  worse  than  making  no  decision  at 
all.  A  mind  that  has  habituated  itself  to  slow  processes  of  reason- 
ing would  probably  fail  to  acquit  itself  creditably  ni  a  position 
requiring  quick  decisions.  On  the  other  hand,  a  "snap  judgment" 
mind  that  has  no  sound  basis  for  its  decisions  is  sure  sooner  or 
later  to  carry  its  enterprise  on  the  rocks  of  disaster. 

1  Karl  Pearson,  The  Grammar  of  Science,  pp.  32-33.  'By  collect- 
ing all  facts  which  bore  in  any  way  on  tlie  variation  of  animals 
and  plants  under  domestication  and  nature,  some  light  might  per- 
haps be  thrown  on  the  whole  subject.  My  first  note-book  was 
opened  in  July,  1837.  I  worked  on  true  Baconian  principles,  and, 
without  any  theory,  collected  facts  on  a  wholesale  scale,  more 
especially  with  respect  to  domesticated  productions,  by  printed  in- 
quiries, by  conversation  with  skilful  breeders  and  gardeners,  and 
by  extensive  reading.  When  I  see  the  list  of  books  of  all  kinds 
which  I  read  and  abstracted,  including  whole  series  of  Journals 
and  Transactions,  I  am  surprised  at  my  own  industry.  I  soon 
perceived  that  selection  was  the  keystone  of  man's  success  in 
making  useful  races  of  animals  and  plants.' 

"Here  we  have  Darwin's  scientific  classification  of  facts,  what  he 
himself  terms  his  'systematic  inquiry.'  Upon  the  basis  of  this 
systematic  inquiry  comes  the  search  for  a  law.  This  is  the  work 
of  the  imagination;  the  inspiration  in  Darwin's  case  being  apparently 
due  tc  a  perusal  of  Malthus'  Essay  on  Population.  But  Darwin's 
imagination  was  of  the  disciplined,  scientific  sort.  Like  Turgot, 
he  knew  that  if  the  first  thing  is  to  invent  a  system,  then  the 
second  is  to  be  disgusted  with  it.  Accordingly  there  follows  the 
period  of  self-criticism,  which  lasted  four  or  five  years,  and  it 
was  no  less  than  nineteen  years  before  he  gave  the  world  his  dis- 
covery in  its  final  form.  Speaking  of  his  inspiration  that  natural 
selection  was  the  key  to  the  mystery  of  the  origin  of  species,  he 
says : 

"'Here  then,  I  had  at  last  got  a  theory  by  which  to  work;  but 
I  was  so  anxious  to  avoid  prejudice,  that  I  determined  not  for 
some  time  to  write  even  the  briefest  sketch  of  it.  In  June,  1842 
(i.e.,  four  years  after  the  inspiration),  I  first  allowed  myself  the 
satisfaction  of  writing  a  very  brief  abstract  of  my  theory  in  pencil 
in  35  pages;  and  this  was  enlarged  during  the  summer  of  1844 
into  one  of  230  pages,  which  I  had  fairly  copied  out  and  still 
possess.' 


THE  SCIENTIFIC  METHOD  85 

Hasty  conclusions. — Nothing  is  so  deadly  to  progress 
as  the  promulgation  of  unverified  and  faulty  conclusions. 
Take,  for  example,  the  old  idea  that  was  followed  blindly 
by  business  men  for  generations  and  that  still  persists  in 
some  quarters — that  the  lower  the  rate  of  wages,  the 
lower  will  be  the  production  costs,  or  the  other  equally 
erroneous  principle  that  the  longer  hours  people  work, 
the  more  they  produce.  The  fallacies  of  these  archaic 
traditions  are  being  exposed  through  the  patient  investi- 
gation of  trained  investigators.^  The  persistence  of  these 
traditions  is  sometimes  amusing.  Every  progressive 
town  in  the  United  States  perhaps  has  its  newer  section  of 
fine  homes,  that  is  dubbed  "mortgage  hill"  or  "mortgage 
addition,"  the  inference  being  that  the  owners  are  guilty 
of  extravagance  and  false  pride.  The  fact  is  that  the 
owners  generally  are  business  men  who  understand  the 
financial  principle  of  "trading  on  the  equity"  and  mort- 
gage their  houses  at  six  per  cent  to  use  the  money  in  earn- 
ing 20  per  cent  in  their  businesses. 

Deduction. — As  was  indicated  above,  the  logical  proc- 
ess that  will  be  most  useful  to  the  practical  business  man 
is  deduction.  He  will  take  the  business  laws  and  apply 
them.     The  typical  process  of  deduction  is  the  syllogism : 

All  men  are  mortal. 
John  is  a  man. 
Therefore,  John  is  mortal. 

This  form  of  reasoning  is  constantly  being  used  in  busi- 
ness, though  perhaps  the  formal  steps  are  not  expressed. 
Thus  we  say  that  an  industrial  company  ought  not  gen- 

"Finally  an  abstract  from  Darwin's  manuscript  was  published 
with  Wallace's  Essays  in  1858,  and  the  Origin  of  Species  appeared 
in  1859." 

^  See  Josephine  Goldmark,  Fatigue  and  Efficiency. 


S6  PRINCIPLES  OF  BUSINESS 

erally  to  issue  bonds.     This  may  be  worked  out  at  greater 
length : 

Businesses  with  uncertain  revenues  should  not  issue  bonds. 
Industrials  have  uncertain  revenues. 
Therefore,  industrials  should  not  issue  bonds. 

We  cannot  go  into  the  difficulties  that  may  arise  in  this 
form  of  reasoning.  Some  of  them  have  already  been 
alluded  to :  the  first  sentence,  or  major  premise,  is  the 
general  law  derived  by  inductive  reasoning,  and  this,  we 
said,  must  be  true,  and  be  proven  to  be  true  by  examina- 
tion of  countless  cases.  One  difficulty  is  illustrated  by 
the  syllogism  itself.  When  deduction  is  expressed  in  a 
formal  syllogism,  there  is  a  tendency  to  make  it  as  con- 
cise as  possible,  and  the  major  premise  (businesses  with 
uncertain  revenues  should  not  issue  bonds)  is  made  too 
sweeping.  A  more  correct  statement  of  this  premise  is 
that  businesses  may  issue  bonds  with  safety  only  in  pro- 
portion to  the  stability  of  their  net  income.  An  indus- 
trial, for  example,  can  with  safety  issue  bonds  up  to  an 
amount  the  interest  on  which  is  not  in  excess  of  its  net 
income  in  its  poorest  year,  and  it  is  erroneous  to  say, 
therefore,  that  industrials  should  not  issue  bonds  at  all. 

Deduction  presupposes  analysis. — Laws  cannot  be 
applied  to  situations  until  they  are  analyzed.  The  minor 
premise  must  be  correct.  We  must  be  sure  that  indus- 
trials, in  the  example  already  given,  have  uncertain  reve- 
nues. 

To  analyze  a  business  situation  requires  a  trained  and 
informed  mind.  Indeed,  business  problems  sometimes 
seem  almost  incapable  of  solution  because  it  is  impos- 
sible to  analyze  them.     Price-fixing  is  a  case  in  pomt 


THE  SCIENTIFIC  METHOD  87 

Frequently  the  problem  is  so  complex  that  changes  occur 
almost  before  the  original  facts  are  classified.  A  good 
example  of  analysis  will  be  found  in  any  Public  Utility 
Rate-Making  Decision. 

Importance  of  analysis  of  business  problems. — Few 
business  men  would  care  to  put  money  into  an  enterprise 
before  its  possibilities  have  been  adequately  analyzed.^ 
We  are  constantly  putting  money  into  enterprises  and 
sometimes  without  adequate  analysis.  Mr.  Harry  Tipper 
gives  an  example  that  has  been  quoted  by  Cherington  in 
his  Advertising  as  a  Business  Force,  p.  25.  "The  usual 
plan  in  by  far  the  majority  of  cases  where  it  is  decided  to 
market  a  new  product  is  to  start  a  few  salesmen  on  what 
would  appear,  from  a  personal  impression  or  general 
knowledge  of  the  trade,  to  be  the  most  important  markets 
and  feel  the  thing  out  in  this  way.  An  expenditure  of 
$20,000  to  $50,000  is  easily  absorbed  in  this  experimen- 
tation without  developing  such  information  as  would 
form  the  basis  for  an  examination  into  the  possible  effi^ 
ciency  of  selling  and  the  possible  profit  to  be  secured. 
Personal  impressions,  even  those  of  one  or  two  men  who 
have  been  brought  up  in  the  industry,  are  easily  misled, 
by  appearances  and  local  conditions  through  restricted 
fields,  into  an  entirely  wrong  conception  of  the  market 
and  the  methods  to  be  adopted  in  covering  such  market 
most  efficiently.  In  working  out  a  case  a  few  years  ago, 
the  writer  was  particularly  struck  with  this  condition. 

"The  plant  in  question  had  a  capacity  which  was  con- 
sidered by  the  experienced  sales  manager  to  be  quite  small. 

^  For  an  example  of  the  analysis  of  a  projected  enterprise  see 
Gersteiiberg's  Materials  of  Corporation  Finance,  pp.  457  et  seq. 
See  also  Fischer's  Economics  of  Interurban  Railways. 


88  PRINCIPLES  OF  BUSINESS 

It  was  also  concluded  by  this  gentleman  that  $15,000  or 
$20,000  could  be  spent  for  advertising  this  particular 
output  in  addition  to  the  organization  of  a  considerable 
sales  force. 

"Knowing  very  little  of  the  trade  conditions  in  this 
field  and  being  impressed  with  the  lack  of  statistics  on  the 
subject,  the  writer  made  an  investigation,  which  was 
carefully  carried  out,  into  the  possible  market  along  the 
lines  in  which  it  was  proposed  to  sell  the  article  in  ques- 
tion, 

"This  investigation  showed:  (a)  that  the  personal  im- 
pression or  judgment  of  the  sales  department  was  utterly 
at  fault  and  that  the  writer's  judgment  was  equally  out 
of  line  with  the  facts;  (b)  that  the  total  consumption  of 
the  article  in  question  in  the  field  proposed  did  not  ab- 
sorb more  than  one-fourth  or  one-fifth  of  the  capacity  of 
the  plant,  and  anywhere  from  one-eighth  to  one-tenth  of 
the  amount  expected;  (c)  that  the  cost  of  the  advertising 
and  sales  organization  proposed  would  have  been  entirely 
out  of  line  from  the  standpoint  of  possible  consumption 
within  the  near  future. 

"While  this  was  an  unusual  case,  on  account  of  cir- 
cumstances in  the  industry  involved,  which  made  the 
apparent  importance  of  the  business  much  greater  than 
there  was  any  warrant  for,  it  showed  conclusively  the 
necessity  for  investigation  of  the  trade  conditions  in  order 
to  form  a  reasonable  basis  for  the  formation  of  a  selling 
plan;  and  inasmuch  as  advertising  is  a  part  of  the  selHng 
plan,  the  same  necessity  arose  in  the  determination  of  the 
extent,  method  and  conditions  of  the  advertising. 

"Apart  from  such  an  unusual  condition  as  this,  the 


THE  SCIENTIFIC  METHOD  89 

excessive  cost  of  selling,  due  to  promotion  and  sales  work, 
covering  fields  and  methods  which  the  consumption  of  the 
articles  would  not  warrant,  has  jiist  as  much  to  do  with 
the  difficulties  in  many  organizations  as  the  over-capitali- 
zation of  physical  properties. 

"I  have  in  mind  a  plant  in  the  Middle  West  where, 
although  the  business  had  increased  to  the  extent  of  re- 
quiring double  the  capacity  to  fill  it,  the  waste  of  efficiency 
in  selling  and  the  consequent  enormous  promotion  ex- 
penses made  it  impossible  for  this  firm  to  realize  sufficient 
profit  to  pay  a  dividend. 

"It  is  well  known  that  usually  the  expense  of  marketing 
equals  100  per  cent  of  all  the  other  factors  entering  into 
the  cost  of  an  article,  and  in  quite  a  number  of  cases  the 
proportion  is  even  greater. 

"This  being  so,  it  is  evident  that,  in  order  to  approach 
the  question  of  marketing  any  particular  material,  it  is 
necessary  that  the  basic  information  should  be  at  hand. 
This  should  be  arranged  in  such  shape  that  an  intelligent 
investigation  can  be  made  with  a  view  to  approaching  the 
market  of  the  product  with' a  high  degree  of  efficiency." 

The  importance  of  scientific  methods. — We  have 
very  briefly  described  the  essentials  of  scientific  method. 
These  essentials  consist  of  observation,  analysis,  defini- 
tion, classification,  inference  and  verification,  plus  the  de- 
ductive method — that  of  applying  general  laws  to  particu- 
lar problems.  There  seems  to  be  little  danger  that  Amer- 
ica will  make  of  method  or  efficiency  a  fetish  the  worship 
of  which  will  lead  us  into  such  barbarities  as  have  been 
committed  by  the  most  radical  of  the  exponents  of  scien- 
tific method.     Indeed,  we  can  safely  lay  stress  upon  the 


90  PRINCIPLES  OP  BUSINESS 

importance  of  scientific  method  as  a  means  to  a  fuller 
economic  life  that  will  leave  time  and  energy  for  the  pro- 
motion and  enjoyment  of  things  spiritual  and  aesthetic. 
"The  scientist  is,  in  the  broad  sense,  a  creator  of  wealth 
as  truly  as  is  the  .man  whose  attention  is  focused  on  the 
application  of  science.  Indeed,  the  scientist  is  merely  the 
scout,  the  explorer,  who  is  sent  on  ahead  to  discover  and 
open  up  new  leads  to  nature's  gold.  His  motive  may  be 
merely  to  find  out  how  nature  works,  but  once  that 
knowledge  has  been  gained,  man  almost  always  finds  a 
way  to  apply  it  to  his  own  ends,  so  that  in  a  very  real 
sense  all  scientific  effort  is  directed  toward  the  improve- 
ment of  human  well-being  by  creating  more  wealth."  ^ 
Finally,  science  alone  can  lead  to  future  achievement.^ 
Analysis. — Facts,  however  obtained,  are  of  no  value 

^  From  R.  A  Millikan,  "Twentieth  Century  Physics,"  Smithsonian 
Report  for  1918,  pp.  169-84,  and  "A  New  Opportunity  in  Science," 
Science,  N.  S.,  Vol.  L.  (1919)  pp.  285-97,  contained  in  Marshall's 
Business  Administration,  p.  533. 

*  Jones,  Business  Administration.  "The  first  care,  therefore,  of 
the  business  community  should  be  sound  methods.  We  hear  much 
of  governmental  and  other  reforms  which  are  feared  because  they 
will  disturb  business.  It  is  safe  to  say  that  there  is  hardly  any 
probable  destruction  of  property  which  will  not,  in  the  long  run, 
prove  immensely  profitable,  if  it  is  the  price  which  must  be  paid 
for  a  superior  method.  To  say  this  is  merely  to  apply  the  well- 
established  American  principle  of  scrapping  obsolete  equipment 
to  the  problem  of  getting  rid  of  superseded  and  worn-out  methods 
and  policies. 

"The  paramount  value  of  rnethods  was  emphasized  by  Mr.  Car- 
negie, when  he  said,  'Take  away  all  our  factories,  our  trade,  our 
avenues  of  transportation,  our  money;  leave  me  our  organization, 
and  in  four  y«ars  I  shall  have  re-established  myself.'  Results 
change  from  day  to  day ;  scientific  methods  are  a  heritage  of  in- 
tangible capital  of  more  permanent  value.  Results  represent  past 
conditions ;  methods  prepare  for  what  is  to  come.  To  possess 
efficient  methods  is  to  have  the  power  to  recover  lost  results,  or 
to  replace  obsolete  results  at  will ;  but  to  possess  results  witli  inade- 
quate methods  is  to  begin  at  once  to  fall  behind.  Results  may  be 
acquired  by  accident ;  methods  are  transmitted  only  by  the  slow 
growth  of  habits.  Results  may  be  easily  transferred;  to  the  at- 
tainment of   superior  methods  there  is  unhappily   no   royal   road." 


THE  SCIENTIFIC  METHOD  91 

till  they  are  analyzed  and  classified.  Only  after  they 
have  been  analyzed  can  the  like  facts  be  drawn  together 
preparatory  to  studying  them  as  a  step  in  discovering  a 
law.  The  analysis,  in  the  first  place,  should  inform  the 
investigator  as  to  the  homogeneity  of  the  facts  about  to 
be  studied.  An  example  will  make  this  clear:  Some 
years  ago  an  expert  was  employed  by  an  advertising  asso^ 
ciation  to  discover  the  laws  of  advertising  value  in  the 
various  positions  on  the  two  pages  of  a  magazine — the 
right  and  the  left.  The  experiments  were  conducted  in  a 
class  in  a  leading  university,  and  ordinary  magazines  were 
used.  The  first  report  was  found  to  be  almost  valueless, 
since  the  effect  of  extraneous  conditions  was  not  taken 
into  consideration.  In  measuring  the  attention  value  of 
the  different  positions,  no  allowance,  for  example,  was 
made  for  differences  in  copy,  in  illustrations,  or  in  type 
faces.  The  experiments  had  to  be  tried  all  over  again, 
and  in  the  second  set  of  experiments  "dummies"  were 
used  in  which  copy,  illustrations  and  other  incidents  were 
made  uniform. 

The  business  man  and  the  business  student  should  con- 
stantly be  on  guard  against  faulty  analyses.  Examples 
of  conclusions  drawn  before  proper  analysis  has  taken 
place  will  constantly  be  found.  Thus  in  studying  busi- 
ness activity  it  is  customary  to  compare  the  bank  clearings 
of  one  period  with  those  of  another  without  making 
allowance  for  the  facts  that  bank  clearings  are  affected 
in  volume  not  only  by  the  volume  of  business  but  also 
by  the  level  of  prices.^ 

^  Bank  clearings,  the  author  has  suggested,  can  be  made  a  better 
index  of  the  volume  of  business  if  first  divided  by  the  index  num- 
ber of  commodity  prices. 


Q2  PRINCIPLES  OF  BUSINESS 

Analysis  should  be  sufficiently  detailed. — If  a  proper 
conclusion  concerning  a  set  of  facts  is  to  be  reached,  the 
analysis  must  be  sufficiently  detailed  to  take  account  of 
each  separate  factor.  Thus  we  may  wish  to  find  the 
proper  wage  to  pay  for  a  given  kind  of  work.  When  that 
wage  is  found  it  may  be  called  the  law  of  wages  for  that 
kind  of  work.  That  the  law  will  be  faulty  unless  the 
analysis  is  made  in  adequate  detail  is  nicely  illustrated  by 
an  experience  related  by  Dr.  Frederick  Winslow  Taylor 
in  his  Shop  Management,  pp.  83-85.  "When  work  is  to 
be  repeated  many  times,  the  time  study  should  be  minute 
and  exact.  Each  job  should  be  carefully  subdivided  into 
its  elementary  operations,  and  each  of  these  unit  times 
should  receive  the  most  thorough  time  study.  In  fixing 
the  times  for  the  tasks,  and  the  piece-work  rates  on  jobs 
of  this  class,  the  job  should  be  subdivided  into  a  number 
ot  divisions  and  a  separate  time  and  price  assigned  to  each 
division  rather  than  to  assign  a  single  time  and  price  for 
the  whole  job.  This  should  be  done  for  several  reasons, 
the  most  important  of  which  is  that  the  average  workman, 
in  order  to  maintain  a  rapid  pace,  should  be  given  the 
opportunity  of  measuring  his  performance  against  the 
task  set  him  at  frequent  intervals.  Many  men  are  in- 
capable of  looking  very  far  ahead,  but  if  they  see  a  defi- 
nite opportunity  of  earning  so  many  cents  by  working 
hard  for  so  many  minutes,  they  will  avail  themselves  of  it. 

"As  an  illustration,  the  steel  tires  used  on  car  wheels 
and  locomotives  were  originally  turned  in  at  the  Midvale 
Steel  Works  on  piece  work,  a  single  piece-work  rate  being 
paid  for  all  of  the  work  which  could  be  done  on  a  tire 
at  a  single  setting.     A  fixed  price  was  paid  for  this  work, 


THE  SCIENTIFIC  METHOD  93 

whether  there  was  much  or  Httle  metal  to  be  removed,  and 
on  the  average  this  price  was  fair  to  the  men.  The  ap- 
parent advantage  of  fixing  a  fair  average  rate  was,  that  it 
made  rate-fixing  exceedingly  simple,  and  saved  clerk  work 
in  the  time,  cost  and  record  keeping. 

"A  careful  time-study,  however,  convinced  the  writer 
that  for  the  reasons  given  above  most  of  the  men  failed 
to  do  their  best.  In  place  of  the  single  rate  and  time  for 
all  of  the  work  done  at  a  setting,  the  writer  subdivided 
tire-turning  into  a  number  of  short  operations,  and  fixed 
a  proper  time  and  price,  varying  for  each  small  job, 
according  to  the  amount  of  metal  to  be  removed,  and  the 
hardness  and  diameter  of  the  tire.  The  effect  of  this 
subdivision  was  to  increase  the  output,  with  the  same  men, 
methods,  and  machines,  at  least  thirty-three  per  cent." 

Analysis  the  basis  of  "Scientific  Management." — 
Analysis  is  at  the  basis  of  so-called  "Scientific  Manage- 
ment." When  industrial  units  were  small  a  minute  waste 
in  a  certain  process  was  not  felt  much  in  the  first  profits. 
Besides,  the  margin  of  profits  was  broad  enough  to  absorb 
such  wastes.  But  as  competition  increased,  and  the  mar- 
gin of  profits  contracted  and  the  processes  of  large  units 
of  industry  were  repeated  many  times,  these  wastes  mul- 
tiplied the  losses  and  some  analysis  of  the  steps  had  to  be 
made  to  cut  out  those  steps  that  were  unnecessary  and  to 
facilitate  the  operations  that  were  performed  awkwardly 
— that  is,  with  a  waste  of  energy.  Thus  grew  up  the 
science  of  cost  analysis.  Moreover,  as  the  labor  question 
loomed  large  on  the  horizon,  and  as  men  began  to  feel 
that  its  solution  rested  on  a  payment  to  laborers  in  pro- 
portion to  what  they  actually  contributed  in  the  produc- 


94  PRINCIPLES  OF  BUSINESS 

tion  of  goods  and  sciences,  analysis  of  work  had  to  be 
made  every  minute  to  arrive  at  a  reasonable  wage-rate 
system.     This  analysis  took  the  form  of  "time  studies."  * 

CLASSIFICATION    AND   DEFINITION 

Classification  and  definition. — In  building  up  any  sci- 
ence much  depends  on  careful  observation,  but  after  all, 

1  Church,  Science  and  Practice  of  Management,  pp.  12-14.  "The 
principle  of  time  study  is,  in  essence,  the  analysis  of  something 
into  its  elements,  and  observation  of  the  times  taken  by  a  skilful 
operator  to  perform  these  elements.  By  adding  the  times  together, 
it  is  possible  to  get  a  very  close  approximation  to  what  may 
reasonably  be  considered  the  standard  time  for  the  whole  job. 

"This,  of  course,  is  merely  doing  systematically,  and  in  an  exact 
way.  what  the  foreman  or  rate-setter  did  mentally  and  by  the  aid 
of  his  experience.  Such  a  man  did  not  really  guess  at  the  proper 
time.  He  rapidly  ran  over  in  his  mind  the  successive  steps  to  be 
taken,  and  pictured  them  to  himself,  allotting  the  proper  time  to 
each,  and  thus  arrived  at  a  result.  The  diflference  between  his  work 
and  that  of  a  time-study  man  was,  chiefly,  th3t  he  gave  the  answer, 
but  did  not  disclose  the  workings.  The  latter  records  every  detail 
of  the  way  in  which  he  arrives  at  the  result,  with  the  obvious 
advantage  that  criticisms  and  corrections  may  be  made,  and  even 
the  details  themselves  may  be  of  importance  for  future  reference. 

"To  understand  what  it  is  that  time  study,  as  an  instrument  of 
analysis,  really  does,  we  may  suppose  that  a  man  undertakes  an 
odd  kind  of  journey  for  a  bet.  He  undertakes  to  run  three  miles, 
walk  five,  swim  half-a-mile,  ride  a  bicycle  two,  crawl  one,  and  hop 
half-a-mile,  finally  ending  up  by  taking  an  aeroplane  and  flying 
six  miles.  And  he  undertakes  to  do  all  this  within  a  given  time. 
Now  to  look  at  the  problem  as  a  simple  matter  of  traveling  eigh- 
teen miles  will  not  give  us  a  good  idea  of  the  possible  time  it  will 
take.  H  we  are  to  make  a  wager  with  him — if,  for  instance,  we 
are  to  give  him  fifty  dollars  if  he  completes  the  journey  within  a 
certain  limit  of  time — it  is  obvious  that  we  shall  be  in  a  very 
unsafe  position  if  we  do  not  carefully  analyze  each  of  the  different 
kinds  of  progression  that  he  has  to  make,  and  reckon  up  his 
probable  speed  as  regards  each. 

"H,  on  the  other  hand,  we  make  a  list  of  the  different  kinds  of 
movement  he  has  to  make,  and  apply  our  experience  to  assess  his 
possible  speed  in  each  kind,  and  then  aggregate  the  items,  we  shall 
be  fairly  close  to  a  "sporting  chance."  But  if  we  happen  to  have 
at  hand  trustworthy  data  of  record  speeds  in  each  of  these  dif- 
ferent kinds  of  movements,  then  we  shall  be  able  to  make  a  very 
close  wager,  and  it  will  depend  on  the  man  himself  whether  he 
rises  to  the  occasion  or  not.  Time  study,  as  applied  to  jobs,  works 
exactly  in  this  way." 


THE  SCIENTIFIC  METHOD  95 

observation  involves  a  comparatively  lower  form  of  in- 
telligence than  the  next  steps,  analysis  and  classification. 
We  observe  with  our  senses  but  analyze  and  classify  with 
our  reasoning  powers.  Classification  "denotes  the  sys- 
tematic association  of  kindred  facts,  the  collection,  not 
of  all,  but  of  relevant  and  crucial  facts.''  ^  In  some 
sciences,  as  in  Zoology,  classification  is,  perhaps,  the  final 
purpose  of  the  scientist,  but  in  most  of  the  sciences,  while 
classification  may  serve  many  ends,  it  is  primarily  to  be 
considered  merely  as  a  step  in  tlie  important  task  of  dis- 
covering the  laws  which  may  explain  the  facts  classified. 
Kinds  of  classification. — Scientists  recognize  by  name 
several  kinds  of  classification  but  are  not  always  clear  as 
to  the  true  differences  between  the  various  kinds  named. 
In  general  it  may  be  said  that  classification  may  be  for  one 
or  two  purposes,  and  therefore  may  be  of  two  kinds — 
first  is  the  classification  the  purpose  of  which  is  merely  to 
help  us  locate  things.  Such  a  classification  one  will  find 
in  the  classification  of  books  in  the  catalogue  of  a  library. 
The  simpler  such  a  classification  is  the  better.  Even  the 
eminent  scientist,  W.  S.  Jevons,  in  his  The  Principles 
of  Sciefice,  says,  "My  own  experience  entirely  bears  out 
the  opinion  that  classification  according  to  the  name  of 
the  author  is  the  only  one  practicable  in  a  large  library."^ 
The  other  form  of  classification  is  that  which  tells  some- 
thing about  the  things  grouped  together.  From  the 
standpoint  of  the  student  of  science,  that  classification  is 
best  which  is  based  on  essential  qualities  of  the  facts  or 

^  Karl  Pearson's  The  Grammar  of  Science,  p.  77. 

-  But  the  arranging  of  books  on  the  shelf  in  accordance  with  a 
"subject"  classification  instead  of  an  "author"  classification  is  un- 
doubtedly useful  to  the  average  person  who  has  actual  access  to 
the  shelves. 


96  PRINCIPLES  OF  BUSINESS 

thing's  classified  and  which,  therefore,  tells  essential  facts 
about  all  the  things  in  a  given  class. 

Classification  into  genus  and  species. — After  a  group 
of  things  have  been  divided  into  main  groups,  the  classi- 
fication may  be  carried  further  into  sub-groups.  A  class 
which  is  divided  into  sub-classes  is  called  a  genus  while 
the  sub-classes  are  called  species.  The  species  may  again 
be  divided  into  other  species,  and  in  that  case  the  original 
species  will,  as  to  the  second  group  of  species,  be  regarded 
as  a  genus. 

Definition. — One  of  the  most  difficult  tasks  of  the 
scientist  is  to  define.  A  simple  method  of  defining  is  to 
point  out  the  object  or  to  describe  it.  But  these  methods 
are  not  sufficient  for  scientific  purposes.  *Tf  one  should 
point  to  a  horse,  he  might  mean  any  one  of  a  dozen  of 
different  things :  horse,  or  simply  animal,  or  useful  ani- 
mal, or  large  object,  or  gray,  or  beautiful,  or  dangerous 
and  so  on."  ^  A  more  satisfactory  method  is  to  state 
the  class  or  genus  to  which  the  thing  defined  belongs  and 
the  differentia  which  distinguish  it  from  other  things  in 
that  class.  Thus  a  table  is  a  board  (genus)  supported  on 
the  four  corners  in  a  horizontal  position  by  legs  (differ- 
entia). 

Thus  it  will  be  seen  that  in  defining  things,  we  must  al- 
ways classify  them.  The  question  may  be  asked.  Do  we 
choose  the  main  class  or  one  of  the  sub-classes?  Evi- 
dently the  smaller  the  sub-class  we  can  choose  the  nearer 
we  will  come  to  identifying  the  object  at  the  outset. 
Thus  to  call  a  certificate  of  stock  a  corporate  instrument, 
instead  of  a  legal  instrument,  or  just  an  instrument  in 

^Jones's  Logic,  Inductive  and  Deductive, p.  58. 


THE  SCIENTIFIC  METHOD  97 

writing,  puts  us  more  quickly  in  touch  with  the  object 
to  be  defined. 

Importance  of  selecting  proper  class. — The  chief 
difficulty  in  defining  is  experienced  by  untrained  minds  in 
placing  objects  in  the  proper  genus.  Thus,  what  is  a 
share  of  stock?  It  is  not  an  instrument  in  writing;  the 
instrument  in  writing  is  merely  the  certificate  of  stock 
which  represents  the  share. 

Importance  of  definition  and  classification  in  busi- 
ness.— The  science  of  business  is  crying  for  exact  defini- 
tion and  scientific  classification.  One  needs  to  go  no 
further  than  the  income-tax  legislation  to  find  a  phase  of 
business  presenting  thousands  of  questions,  all  of  which 
could  be  answered  by  definition  or  classification.  Even 
elementary  discussions  in  economics  often  sufifer  for  lack 
of  clear  definition.  Take  the  word  "property."  People 
confuse  property  with  "wealth"  because  they  do  not  get 
those  terms  into  their  proper  classes.  Property  consists 
of  rights — in  other  words,  of  intangible  relationships 
existing  between  things  and  people,  while  wealth  consists 
of  the  things  themselves. 

The  whole  subject  of  accounting  as  well  as  that  of 
finance  labors  under  the  difficulty  of  nomenclature  con- 
sisting of  words  that  are  not  actually  defined  and  used 
by  business  men.  What  is  actually  meant  by  "deprecia- 
tion," "quick  assets,"'  "capital,"  "expenses" — these  are 
but  a  few  of  the  questions  that  have  caused  much  discus- 
sion, oral  and  written.  And  it  may  happen  that,  as  in  the 
case  of  the  Excess  Profits  Tax,  thousands  of  dollars  may 
be  at  stake  in  the  application  of  a  general  definition  to 
any  given  term.     For  example,  is  a  stock  dividend  in- 


98  PRINCIPLES  OF  BUSINESS 

come  in  the  hands  of  the  stockholders?  The  settlement 
of  that  question  one  way  or  the  other  meant  millions  upon 
millions  of  dollars  to  the  Government  and  to  stockholders. 

Importance  of  authority  in  framing  definitions. — 
One  of  the  difficulties  in  the  fomiulation  of  definitions  of 
terms  pertaining  to  the  science  of  business  is  that  the 
science  itself  is  comparatively  young,  and  commentators 
have  not  had  time  to  frame  definitions  that  meet  with  uni- 
versal acceptance.  From  time  to  time,  however,  busi- 
ness terms  come  before  the  courts  and  then  the  law,  speak- 
ing through  the  courts,  defines  these  terms  with  an  au- 
thority that  cannot  be  disregarded.^  In  the  same  way, 
legislatures  and  administrative  departments  of  the 
Government  sometimes  give  authoritative  definitions. 
Not  the  least  important  benefit  of  the  income  tax  laws 
will  be  the  authoritative  definition  of  technical  account- 
ing and  financial  terms. 

The  reader  must  be  warned  to  note  the  difference  be- 
tween authoritative,  and  logical  or  scientific.  Thus  some 
of  the  rulings  of  the  Treasury  Department  at  Washington 
may  not  command  the  respect  of  scholarly  accountants, 
but  in  preparing  returns  for  the  tax  these  same  account- 
ants will  have  to  accept  the  definitions  of  the  Treasury 
Department  instead  of  trying  to  follow  their  own  ideas. 

Where  authority  to  define  may  be  found. — If  the 
definition  of  a  term  has  the  sanction  of  some  branch  of 
the  Government,  that  definition  may  be  considered  au- 
thoritative, even  if  not  logical.  Those  who  object  to  the 
definition  may  frequently  find  it  wise  to  abandon  the 

ipor  an  excellent  example  of  judicial  definition  of  business  terms, 
see  Kansas  City  Southern  Ry.  vs.  United  States,  231  U.  S.,  423- 


THE  SCIENTIFIC  METHOD  99 

term  entirely  for  the  use  to  which  they  had  previously  put 
it,  and  to  use  some  other  term  to  express  that  use  or  pur- 
pose. Moreover,  if  it  is  felt  that  an  ''authoritative'' 
definition  narrows  down  unduly  the  meaning  of  a  term 
that  formerly  had  a  broad  meaning,  new  words  raay  be 
"coined"  to  fill  the  vacancy.  Thus,  at  one  time  the  busi- 
ness man  generally  meant  by  "good-will,"  the  excess  of 
capitalized  earning  power  over  the  cost  of  physical  prop- 
erty invested  in  a  business.  Gradually  an  entirely  new 
set  of  words  came  to  take  the  place  of  this  one  word,  and 
today,  as  well  as  "good-will,"'  we  have  such  expressions 
as  "going-concern  value,"  "intangible  assets"  and  the  like. 
The  term  "good-will"  is  used  principally  with  respect  to 
the  assumed  value  of  the  patronage  attaching  to  an  estab- 
lished business,  while  "going-concern"  value  is  used  with 
reference  to  the  value  attaching  to  a  business  by  reason  of 
its  being  organized  and  in  running  order,  and  not  merely 
a  number  of  unrelated  elements. 

The  truth  of  the  matter  is  that  language,  like  life  itself, 
and  like  society,  is  ever  changing;  the  task  of  defining 
terms,  therefore,  will  never  be  completed.  Things  that 
are  to-day  infinia  species  (a  class  that  includes  so  little 
that  it  cannot  be  subdivided)  will  to-morrow  constitute  a 
genus  with  its  subclasses. 

Naturally  business  itself  will  keep  ahead  of  the  law, 
and  new  terms  will  constantly  be  coined  to  meet  new  situ- 
ations. To  bring  order  out  of  the  confusion  created  by 
the  coining  of  new  terms  as  well  as  by  the  use  of  old  terms 
by  people  who  do  not  understand  them,  scientists  fre- 
quently attempt  through  their  learned  societies  to  estab- 
lish authoritative  definitions,  strengthened  bv  the  formal 


lOO  PRINCIPLES  OF  BUSINESS 

approval  of  the  association.  Unfortunately  many  of 
these  attempts  at  the  construction  of  authoritative  glos- 
saries have  been  futile.  So  far  as  the  writer  knows  noth- 
ing has  come  of  the  attempt  of  the  American  Economic 
Association,  a  number  of  years  ago,  to  formulate  a  set 
of  authoritative  definitions  of  economic  terms;  likewise 
nothing  has  come  of  the  attempt  of  the  American  Asso- 
ciation of  Public  Accountants  to  provide  themselves  with 
an  authoritative  uniform  nomenclature.^ 

Importance  of  understanding  the  sense  in  which  a 
word  is  used. — If  language  were  perfect,  no  two  words 
would  mean  the  same  thing,  nor  could  one  word  be  used 
to  do  duty  for  more  than  one  object  or  idea.  Unfortu- 
nately language  is  not  perfect  and  the  careful  student  will 
always  have  to  be  on  the  lookout  for  double  uses  or 
double  meanings.  The  word  capital,  for  example,  is  used 
by  economists  in  one  sense  and  by  business  men  in  an- 
other sense.  The  economist,  when  speaking  of  a  com- 
pany's capital,  means  all  the  wealth  that  the  company  em- 
ploys in  earning  income,  while  the  business  man  means  all 
the  property  owned — not  borrowed — and  used  in  the  busi- 
ness.^ 

Some  typical  classifications  in  business. — To  illus- 
trate how  important  classification  is  in  modern  business, 

^  For  a  typical  report  on  nomenclature,  see  report  of  the  Special 
Committee  to  Formulate  Principles  and  Alethods  for  the  Valuation 
of  Railroad  Property  and  Other  Utilities,  Jan.  17,  1917,  Meeting 
of  the  American  Association  of  Civil  Engineers. 

-  Notice  that  in  the  use  of  the  word  capital  in  the  Excess  Profits 
Tax  Law  of  1917,  Congress  did  not  harm  either  of  these  conceptions 
of  the  word  "capital."  Very  properly,  and  merely  by  adding  an 
adjective,  it  coined  a  new  term  to  express  what  it  had  in  mind — 
invested  capital.  In  the  same  way  some  careful  writers  supply  the 
terms  "business  capital"  and  "economic  capital."  See  Conlin,  igi8 
Income  and  Federal  Tax  Reports,  pp.  639-698. 


THE   SCIENTIFIC  METHOD  loi 

a  brief  explanation  may  be  given  of  some  well-known  and 
important  classifications. 

The  Interstate  Commerce  Commission's  Classifica- 
tion of  Accounts. — The  classification  of  accounts  of  rail- 
roads furnishes  a  good  example  of  the  very  slow  progress 
that  is  made  by  professional  associations  in  formulating 
uniform  definitions.  "The  American  Association  of 
Railway  Accounting  Officers  has  been  in  existence  ever 
since  the  early  history  of  railroads,  but  although  its  mem- 
bers met  and  discussed  theories  and  practices  of  keeping 
railroad  accounts,  there  was  no  recognized  uniform  sys- 
tem."^ In  1870,  a  convention  of  State  railroad  commis- 
sioners held  at  Saratoga,  New  York,  discussed  the  ques- 
tion of  uniform  terminology  in  railroad  accounting  and 
adopted  a  scheme  for  a  certain  uniformity  of  accounts. 
This  was  later  drawn  upon  by  the  Interstate  Commerce 
Commission  when  the  Commission  issued  orders  requir- 
ing uniform  annual  reports.  In  1897  the  Commission 
classified  construction  accounts.  Not  until  1906,  how- 
ever, did  it  have  power  to  compel  the  railroads  to  in- 
terpret its  classification  uniformly.  Some  idea  of  the  ex- 
tent to  which  the  Commission  has  gone  in  its  classification 
and  in  the  interpretation  of  its  classification  may  be 
gained  from  the  fact  that  an  alphabetical  index  of  the 
items  of  operating  expenses  of  railroads  is  printed  in  a 
pamphlet  of  297  pages. 

The  classification  of  accounts  itself  is  a  good  example 
of  a  classification  intended  to  set  forth  something  about 
facts.  "In  drafting  a  system  of  railroad  accounts,  two 
motives  appear  to  have  actuated  the  Interstate  Commerce 

1  Hooper's  Railroad  Accounting,  p.  29. 


102  PRINCIPLES  OF  BUSINESS 

Commission.  The  first  was  the  desire  to  know  actual 
operating  costs  so  as  to  have  a  basis  of  equitable  rate 
making.  The  second  motive  back  of  the  uniform  ac- 
counting system  is  the  desire  for  reliable  statistical  infor- 
mation correctly  portraying  the  financial  status  and  fiscal 
operations  of  the  great  transportation  agencies."  ^  The 
alphabetical  index  of  the  items  in  the  classification  fur- 
nishes a  good  example  of  index  classification. 

Other  classifications  of  business  facts  are  the  customs 
classification  of  imports  and  the  railroad  traffic  classifica- 
tions of  commodities.  Anybody  who  has  had  practical 
experience  with  either  of  these  classifications  will  appre- 
ciate the  importance  of  scientific  classification  and  exact 
definition  in  every-day  business  life. 

Rule  of  scientific  classification. — The  serious  student 
of  business  will  want  to  bring  to  his  study  this  elementary 
rule  of  science  pertaining  to  logical  classification :  A  clas- 
sification should  include  in  its  subclasses  all  that  is  in- 
cluded in  its  main  class  (rule  of  inclusion),  and  the  sub- 
classes should  not  overlap  (rule  of  exclusion).  This  does 
not  mean  that  the  main  class  cannot  be  classified  in  differ- 
ent ways,  but  the  several  classifications  should  not  be 
confused.  Thus  corporations  may  be  classified  ( i )  as 
domestic,  foreign  and  alien;  (2)  as  industrial,  transport- 
ing, public  service,  and  extractive.  The  first  classification 
has  for  its  purpose  the  arranging  of  all  corporations  with 
respect  to  the  location  of  their  legal  residences  considered 
from  the  standpoint  of  any  State  in  the  Union.  The 
second  classification  looks  at  corporations  from  the  stand- 
point of  the  commodities  or  services  they  produce.     A 

1  Sakolski's  American  Railroad  Economics,  p.   172. 


THE  SCIENTIFIC  METHOD  103 

classification,  thus  (a)  domestic,  (b)  railroad,  (c)  ex- 
tractive, (d)  industrial,  would  be  wholly  illogical,  since 
it  violates  both  rules  of  inclusion  and  exclusion  spoken 
of  above,  and  since  it  serves  no  useful  purpose. 


BIBLIOGRAPHY 

Pearson,   Karl,    The   Grannimr  of  Science. 

Jevons,   W.   I.,    The   Principles   of   Science. 

Thompson,   C.   B.,  Scientific  Management. 

Dewey,  John,  Essays  in  Experimental  Logic — Chapter  XIV. 

Jones,   Logic. 

Me'-'S,   C.    E.    K.,    Organization    of   Industrial   Scientific   Research. 


CHAPTER    VI 

FORMS  OF  BUSINESS  ENTERPRISES 

Importance  of  the  form  of  organization. — When  an 
individual  enters  business,  either  actively  or  as  an  in- 
vestor in  a  business  enterprise  managed  by  someone  else, 
he  is  perhaps  as  much  interested  in  the  form  of  the  or- 
ganization as  in  any  other  feature  of  the  business.  This 
is  not  surprising,  for  the  form  of  the  organization  deter- 
mines largely  what  share  of  the  profits  the  individual  may 
obtain  for  himself,  how  much  control  he  can  have  over 
the  business,  and  how  much  risk  he  assumes.  If  he  in- 
vests his  money  and  services  in  a  partnership,  he  may  lose 
not  only  what  he  has  invested,  but  also  every  other  penny 
he  possesses.  In  a  corporation,  on  the  other  hand,  his 
possible  loss  will  be  limited  to  the  amount  of  his  invest- 
ment— except  in  the  case  of  banking  and  other  corpora- 
tions in  which  money  is  held  for  depositors,  in  which 
case  the  liability  may  be  double  the  amount  of  the  invest- 
ment. He  knows  in  advance  what  his  maximum  loss  can 
be.  No  wonder  then,  that  there  has  been  such  a  large 
increase  in  the  corporate  form  of  doing  business! 

Various  forms  of  organization. — The  most  important 
kinds  of  business  organizations  in  America  are  the  indi- 
vidual proprietorship,  the  partnership,  and  the  corpora- 
tion. 

The  individual  proprietorship  is  a  business  enterprise 
owned  by  an  individual,  who  is  usually  the  manager  and 
the  pivot  of  the  business,  as  well  as  its  owner. 

104 


FORMS  OF  BUSINESS  ENTERPRISES      105 

The  partnership  is  a  joint  form  of  individual  pro- 
prietorship. It  is  a  combination  of  the  skill,  property, 
or  money  of  two  or  more  individuals,  who  jointly  own 
and  manage  the  business,  each,  under  the  law,  having  an 
equal  responsibility. 

The  corporation  is  a  device  sanctioned  by  the  Govern- 
ment for  carrying  on  an  enterprise  by  several  persons 
(or  by  one  person)  in  such  a  way  as  to  constitute  the 
enterprise  itself  an  entity  entirely  distinct  from  the  per- 
sons who  are  interested  in  it  and  who  control  it.  This 
makes  possible  the  entire  separation  of  the  ownership  of 
the  business  from  the  management ;  some  persons  may 
furnish  the  capital  to  the  business  and  have  it  actively 
managed  by  others,  who  may  be  removed  at  the  will  of 
the  owners. 

There  are  other  forms  of  organization  that  are  the 
outgrowth  of  these  three.  The  joint-stock  company  is  a 
partnership  with  transferable  shares.  The  limited  part- 
nership is  a  partnership  in  which  some  of  the  partners 
have  a  limited  liability.  The  association  formed  under 
a  deed  of  trust,  or  the  so-called  Massachusetts  trust,  is 
an  adaptation  of  the  corporate  form  to  the  common-law 
trust  created  by  a  will. 

The  individual  proprietorship. — The  individual  pro- 
prietorship is  the  earliest  and  simplest  form  of  business 
organization,  and  even  today  it  is  the  most  prevalent. 
The  small  merchant  likes  to  conduct  his  business  in  this 
form  because  it  is  easy  and  inexpensive  to  create,  and 
because  its  organization  is  very  simple.  No  formal  docu- 
ment need  be  drawn  and  no  organization  fees  or  taxes 
need  be  paid  by  a  business  starting  as  a  sole  proprietor- 


io6  PRINCIPLES  OF  BUSINESS 

ship.  Any  individual  is  free  to  engage  in  such  a  business 
at  will,  and  if  he  finds  that  his  undertaking  is  not  suffi- 
ciently profitable,  he  may  discontinue  it  and  divert  his 
capital  into  more  profitable  channels.  Likewise  with  re- 
spect to  its  management  or  control,  the  individual  pro- 
prietorship is  relatively  free  from  outside  interference. 
The  owner  himself  buys  goods  and  sells  them  again,  pays 
his  help,  or  designates  employees  to  do  these  things  for 
him;  whatever  profit  is  made  is  the  proprietor's  own 
profit,  which  he  may  reinvest  in  the  business  or  otherwise 
dispose  of  as  he  will.  Of  course,  if  he  has  debts  he  must 
pay  them  or  his  creditors  will  seize  his  property.  In 
such  a  case,  if  the  assets  of  the  business  itself  are  not 
sufficient  to  pay  the  debts,  the  creditors  may  take — if 
necessary — all  of  his  other  property.  His  liability  is  un- 
limited. While,  from  the  standpoint  of  the  owner,  this 
may  be  looked  upon  as  a  serious  objection  to  the  individ- 
ual proprietorship  form,  we  must  not  lose  sight  of  the 
fact  that  on  the  other  hand,  since  the  creditors  may  look 
to  all  of  the  owner's  property,  they  are  likely  to  be  in- 
clined to  grant  credit  more  liberally  to  the  individual 
proprietorship  than  to  a  concern  whose  owner's  liability 
is  limited.  The  individual  propnetor,  accordingly,  is 
able  to  secure  a  larger  amount  of  borrowed  working-capi- 
tal, and  consequently  to  do  a  larger  volume  of  business 
and  make  a  larger  amount  of  profits,  than  if  his  liability 
were  limited. 

Naturally,  a  sole  proprietorship  does  not  dften  become 
very  large.  The  success  of  the  business  depends  too 
much  upon  the  presence  and  personal  attention  of  the 
proprietor;  in  case  of  his  sickness  or  death  it  is  doubtful 


FORMS  OF  BUSINESS  ENTERPRISES      107 

what  would  become  of  the  business.  Usually  then,  the 
business  has  only  such  an  amount  of  capital  and  as  many 
employees  as  the  owner  can  give  attention  to  himself, 
although  it  is  possible  for  an  individual  of  extraordinary 
organizing  ability  to  carry  on  a  very  large  business  with 
the  help  of  able  assistants  and  by  means  of  an  intelligent 
division  of  work. 

The  general  partnership. — A  business  of  the  partner- 
ship form  is  very  similar  to  the  individual  proprietorship ; 
but  the  owners  are  two  or  more  in  number.  So  far  as 
the  public,  or  the  law,  is  concerned,  whatever  is  done  in 
or  for  the  business  by  any  one  of  the  partners  is  done  by 
each  and  all.  Thus,  if  any  partner  contracts  a  debt 
within  the  scope  of  the  partnership  business,  not  only  the 
business  assets  are  liable,  but  all  of  the  individual  assets 
of  all  the  partners  are  also  liable.  This  is  true  even  if 
the  debt  has  been  contracted  without  the  consent  of  the 
other  partners,  because,  so  far  as  outsiders  are  concerned, 
each  partner  has  a  right  to  act  for  the  partnership.  If 
the  partners  should  disagree  on  any  point,  it  is  easy  to 
see  that  this  latter  rule  might  lead  to  serious  quarrels  or 
complications. 

Another  objection  to  the  partnership  is  the  constant 
danger  of  its  dissolution.  The  death,  insanity  (mental 
death),  or  bankruptcy  (financial  death)  of  a  partner  auto- 
matically dissolves  the  partnership.  So  does  the  with- 
drawal of  a  partner,  in  spite  of  any  agreement  to  the 
contrary. 

Profits  and  losses  of  the  partnership  may  be  divided  as 
the  partners  may  agree.  If  no  agreement,  however,  has 
been  made  as  to  the  sharing  of  profits  and  losses,  each 


io8  PRINCIPLES  OF  BUSINESS 

partner  receives  an  equal  share  of  the  profits  and  bears 
an  equal  share  of  the  losses,  irrespective  of  the  amount 
each  partner  has  invested  in  the  business. 

Advantages  and  disadvantages  of  partnership. — 
The  partnership  is  formed  without  paying  any  fees  to 
the  State,  and  is  conducted  without  paying  many  of  the 
taxes  to  which  corporations  are  subject.  The  fact  that 
its  members  are  personally  liable  for  its  debts  makes  it 
more  responsible  and  entitled  to  greater  credit.  This 
same  fact,  however,  discourages  the  average  person  from 
joining  a  partnership.  In  view  of  this  objection  and  in 
view  of  the  constant  danger  of  dissolution,  partnerships 
find  it  difficult  to  obtain  much  permanent  capital.  The 
average  investor  prefers  to  put  his  money  into  an  enter- 
prise whose  form  is  such  that  he  may  know  beforehand 
what  his  maximum  loss  can  be  and  such  that  his  interest 
in  it  can  more  easily  be  sold  or  transferred.  If  his  in- 
vestment is  ^n  interest  in  a  partnership,  he  cannot  very 
well  sell  it,  except  to  the  remaining  partners  or  to  a  per- 
son entirely  agreeable  to  them,  for  if  he  did  so,  the  part- 
nership would  be  terminated. 

The  limited  partnership. — A  partnership  is  satisfac- 
tory only  so  long  as  the  partners  know  each  other  well  and 
have  absolute  confidence  in  each  other.  Strangers  would 
not  invest  money  with  such  a  firm,  because  they  could 
not  know  what  liability  they  might  incur  as  partners.  The 
limited  partnership,  accordingly,  has  been  devised,  under 
which  special  partners  may  be  admitted  to  the  partner- 
ship, who  have  no  voice  in  the  management,  but  who 
may  invest  money  and  receive  a  certain  share  of  the 
profits  without  incurring  any  liability  for  debts  of  the 


FORMS  OF  BUSINESS  ENTERPRISES      109 

firm  in  excess  of  the  amount  they  have  invested.  There 
must  be  one  or  more  general  partners  who  manage  the 
busmess  and  who  remain  Hable  as  ordinary  partners  for 
all  the  debts  of  the  business.  Such  a  partnership  is 
formed  only  under  State  statutes,  usually  by  filing  a  cer- 
tificate in  a  public  office  and  publishing  a  notice  in  a 
newspaper. 

The  joint-stock  company. — The  joint-stock  company 
is  a  form  of  partnership  that  lacks  some  of  the  disad- 
vantages of  the  ordinary  partnership.  Like  the  ordinary 
partnership,  each  member  of  the  joint-stock  company  is 
personally  liable  for  all  of  the  debts  of  the  company.  But, 
unlike  the  partnership,  the  ownership  of  the  joint-stock 
company  is  divided  into  shares  which  may  be  sold  from 
one  person  to  another,  without  ending  the  life  of  the 
company.  Instead  of  each  member  having  the  right  to 
act  as  general  agent  for  the  firm,  the  control  is  turned 
over  to  a  board  of  directors  elected  by  the  shareholders 
as  determined  by  the  by-laws.  In  this,  as  well  as  in  its 
form  and  management,  the  joint-stock  company  closely 
resembles  the  corporation. 

It  is  possible  for  a  business  with  this  kind  of  organiza- 
tion to  exist  indefinitely,  since  it  is  not  dependent  upon 
any  one  or  more  individuals  for  its  existence  and  man- 
agement. Moreover,  since  members  may  withdraw  at 
any  time  simply  by  selling  their  shares,  it  is  easy  to  secure 
capital,  if  the  business  is  well-managed  and  profitable. 
The  great  objection  to  the  joint-stock  form  of  organiza- 
tion is  that  the  members  of  the  company  are  personally 
liable  for  the  debts  of  the  company. 

Associations  formed  under  deeds  of  trust. — A  busi- 


no  PRINCIPLES  OF  BUSINESS 

ness  association  formed  under  a  deed  of  trust  is  very 
much  like  a  joint-stock  company  or  corporation  in  out- 
ward appearance.  The  legal  ownership  of  its  property 
is  vested  in  "trustees"  who  hold  the  property  and  manage 
it  for  the  beneficiaries  or  shareholders,  who  for  all  prac- 
tical purposes  are  the  real  owners.  Each  beneficiary  has 
a  certain  number  of  shares  of  the  capital  of  the  business, 
and  these  shares  may  be  sold  as  may  the  shares  of  a  com- 
pany or  a  corporation.  The  difference  is  this,  however, 
that  the  trustees  are  not  elected  annually  or  at  other  stated 
periods  by  the  shareholders,  but  are  appointed  at  the  be- 
ginning and  remain  in  office  until  they  resign  or  are  re- 
moved for  mismanagement  or  other  good  cause.  New 
trustees  then  may  be  appointed  or  elected,  either  by  the 
remaining  trustees  or  by  the  shareholders,  as  may  be 
provided  in  the  deed  of  trust.  Shareholders  in  this  trust 
are  not  personally  liable  for  the  debts  of  the  association. 
Creditors  can  look  only  to  the  trustees,  or  more  usually 
only  to  the  property  of  the  association.  If  the  trust  deed, 
however,  provides  that  the  shareholders  may  remove  the 
trustees  and  appoint  others  to  fill  the  vacancy,  the  associa- 
tion will  be  held  to  be  a  partnership^  and  not  a  trust, 
and  the  shareholders  will  be  liable  to  the  creditors. 
This  liability  the  shareholders  have  usually  avoided 
by  requiring  the  trustees  to  stipulate  in  all  contracts  that 
the  shareholders  shall  not  be  liable. 

Advantages  of  trusts. — The  very  large  industrial 
combinations  and  quasi-monopolies,  which  are  commonly 
called  "trusts,'  are  not  to  be  confused  with  the  business 

^  See  Frost  vs.  Thompson,  219  Mass.  360  and  Williams  vs.  Milton, 
215  MiiSs.  I. 


FORMS  OF  BUSINESS  ENTERPRISES      in 

association  in  which  we  are  at  present  interested.  The 
latter  may  be  formed  to  conduct  any  business,  large  or 
small.  To  organize,  it  is  only  necessary  to  draw  up  an 
instrument  called  a  deed  or  declaration  of  trust, ^  describ- 
ing the  business  of  the  association  and  the  rights  and 
duties  of  the  trustees  and  shareholders.  No  organization 
taxes  to  which  corporations  are  subject,  are  paid  to  the 
State.  Moreover,  the  trust  is  "more  flexible,  more  eco- 
nomical, and  more  convenient  than  the  corporation. 
Trustees  can  do  business  with  more  ease  and  rapidity 
than  a  board  of  directors."  " 

The  trust,  moreover,  does  not  have  the  disadvantage  of 
the  unlimited  liability  of  members  of  the  joint-stock  com- 
pany. 

The  corporation, — In  many  respects  the  corporation 
closely  resembles  the  joint-stock  company.  The  owner- 
ship of  its  capital  is  divided  into  shares  which  are  salable 
like  the  shares  of  a  joint-stock  company.  The  share- 
holders or  members  are  not  agents  of  the  business,  but, 
as  in  the  joint-stock  company,  the  corporation  is  managed 
by  directors  elected  by  the  shareholders.  The  important 
difference  between  the  two  forms  is  this — that  the  share- 
holders of  a  corporation  are  not  personally  liable  for  its 
debts. '^  In  this  respect  the  corporate  form  enjoys  a  dis- 
tinct   advantage ;    the    limited    liability    of    shareholders 

^For  such  an  instrument,  see  Gerstenberg's  Materials  of  Cor- 
porate Finance,  p.  ii. 

'^Report  of  Commissioner  of  Corporation  of  Massachusetts,  Jan- 
uary 17,  1912. 

^^In  some  States,  including  New  York,  shareholders  are  personally 
liable  to  employees  of  the  corporation  for  unpaid  wages.  In  Cali- 
fornia, stockholders  are  personally  liable  for  all  debts  of  the  cor- 
poration. In  practically  all  States,  stockholders  of  banks  and  finan- 
cial institutions  (in  Minnesota,  stockholders  of  all  corporations)  are 
liable  for  twice  the  amount  of  their  subscriptions. 


112 


PRINCIPLES  OF  BUSINESS 


facilitates  the  raising  of  capital,  but  increases  the  diffi- 
culty of  borrowing. 

Organization  and  control  of  corporation. — The  cor- 
poration is  formed  under  State  statutes  permitting  their 
incorporation,  usually  by  filing  a  certificate  in  a  pubHc 
office  and  by  paying  an  "organization  tax"  to  the  State 
treasurer.  Thereafter,  each  year,  the  corporation  is  usu- 
ally required  to  file  a  report  with  the  State  and  pay  a  tax 
for  the  privilege  of  doing  business.  This  is  a  de- 
cided disadvantage  of  the  corporate  form  but  it  is  offset 
to  some  extent  by  ( i )  the  limited  liability  of  shareholders, 
(2)  the  marketability  of  ownership  in  the  company,  (3) 
the  continuous  existence  of  the  organization,  (4)  the 
greater  possibility  of  attracting  investors  and  (5)  its 
adaptability  to  efficient  organization.  As  a  shareholder 
per  se  is  not  an  agent  of  the  corporation,  the  plan  of 
organization  may  be  very  satisfactorily  worked  out.  This 
is  true  also  of  the  joint-stock  company  and  trust.  A  simple 
form  of  organization  is  illustrated  in  the  following  chart : 


Shareholders 
(Who  own  the  business) 


El  ect 


Directors 
(Who  manage  the  business  for 
the  benefit  of  the  shareholders) 


appoint  and  delegate 


active  management  to 


President 


v.  President 


Secretary 


Treasurer 


Other  official* 


FORMS  OF  BUSINESS  ENTERPRISES      113 

These  latter  officers  actively  conduct  the  business 
operations  and  appoint  minor  employees,  They  are  sub- 
ject to  the  control  and  general  supervision  of  the  direct- 
ors, to  whom  they  are  responsible. 

In  order  that  the  corporation  (or  joint-stock  company 
or  trust)  may  be  managed  as  the  stockholders  desire,  the 
stockholders,  upon  the  organization  of  the  company,  draw 
up  and  adopt  a  set  of  by-laws,  setting  forth  the  general 
rules  by  which  the  stockholders  themselves,  the  officials 
and  the  directors  shall  abide.  Among  other  require- 
ments, the  by-laws  provide  that  the  directors  shall  meet 
at  regular  intervals,  to  dispose  of  such  matters  as  may 
require  their  attention. 

Once  or  twice  a  year,  or  even  oftener  in  some  cases,  the 
directors  decide  how  much  of  the  profit  which  has  been 
made  shall  be  reinvested  in  the  business  and  how  much 
shall  be  paid  as  dividends  to  the  stockholders. 

Classes  of  ownership. — When  several  individuals  or, 
perhaps,  a  large  number  contribute  the  capital  an 
enterprise  needs,  some  may  be  so  confident  of  the  success 
of  the  business  that  they  are  willing  to  wait  for  their 
shares  of  the  profits  until  the  less  optimistic  investors 
have  been  paid.  In  compensation  for  the  risk  thsy  as- 
sume, they  naturally  will  require  a  possibility  of  receiving 
larger  profits,  and  perhaps  the  right  to  have  a  dominating 
influence  in  the  control  of  the  company.  On  the  other 
side,  there  will  be  the  cautious  investor,  who  prefers  to  be 
more  certain  of  a  profit,  even  though  it  be  small.  How 
will  it  be  possible  to  give  both  of  these  classes  of  pros- 
pective owners  of  the  enterprise  what  they  desire? 
Simply  through  the  creation  of  different  classes  of  owner- 


114  PRINCIPLES  OF  BUSINESS 

ship  or  stock — one  class  of  stock  being  known  as  common 
or  ordinary  stock,  the  other  being  called  preferred  stock. 

The  most  usual  kind  of  preferred  stock  is  that  desig- 
nated as  preferred  as  to  dividends,  by  which  is  meant  that 
the  holders  of  such  stock  must  receive,  annually,  out  of 
the  first  profits  earned  by  the  corporation  and  distributed 
by  the  directors,  an  amount  equal  to  a  specified  percent- 
age of  the  amounts  of  their  investments — usually  from 
six  per  cent  to  eight  per  cent.  If  the  preferred  stock  is 
non-participating,  as  it  usually  is,  it  cannot  receive  more 
than  the  stipulated  percentage  of  its '  face  value,  even 
though  the  common  stock  should  receive  a  dividend  of 
loo  or  200  per  cent.  The  preferred  stock  having  re- 
ceived its  stipulated  dividend,  the  balance  of  the  profits 
belongs  to  the  common.  If,  however,  the  preferred  stock 
is  participating,  after  it  has  received  its  stipulated  divi- 
dend, of  perhaps  7  per  cent,  it  will  get  a  further  share  of 
the  profits,  either  on  the  same  basis  as  the  common  stock, 
or  in  any  other  ratio  which  the  organizers  may  have  pro- 
vided. If  the  preferred  stock  is  of  the  class  known  as 
cumulative,  the  holders  will  be  more  certain  of  receiving 
their  preference  dividends,  for  if  the  stipulated  dividends 
on  cumulative  preferred  stock  are  not  paid  in  any  one 
year  or  series  of  years,  they  accumulate  as  a  claim  against 
future  profits,  and  must  be  paid  before  the  common  stock- 
holders can  receive  any  dividends  whatever. 

The  preferred  stockholders  are  further  protected  if 
their  stock  is  also  preferred  as  to  assets — in  which  case, 
if  the  corporation  or  association  should  be  dissolved,  the 
preferred  stockholders  would  be  entitled  to  the  amount 
they  originally  contributed,  plus  the  accumulated  pre- 


FORMS  OF  BUSINESS  ENTERPRISES      115 

ferred  dividends,  before  the  common  stockholders  could 
receive  any  of  the  proceeds  of  the  liquidation.  The  pre- 
ferred stock  may  be  made  additionally  attractive  to  the 
investor  by  making  it  convertible.  The  holder  of  con- 
vertible preferred  shares  could  exchange  them  for  shares 
of  common  stock,  if  the  latter  should  ever  become  more 
desirable  than  the  former  because  of  unexpectedly  large 
earnings. 

If  the  co-operators  in  the  enterprise  wish  to  give  a 
certain  class  of  stock  the  entire  control,  they  may  simply 
take  the  voting  power  away  from  all  other  classes.  If 
the  holders  of  the  other  classes  are  apprehensive  lest  this 
power  be  abused,  they  may  be  given  the  right  to  veto 
certain  acts  of  the  holders  of  the  voting  stock — for  ex- 
ample, they  might  be  given  the  right  finally  to  determine 
whether  any  security  which  would  be  superior  to  their 
own  might  be  issued.  Stock  entitling  the  holder  to  exer- 
cise such  vetoing  power  is  called  vetoing  stock. 

It  will  be  seen  then,  that  in  the  corporation,  joint-stock 
company  or  trust,  the  number  of  ways  in  which  income, 
risk  and  control  may  be  divided  among  various  classes  of 
owners  is  limited,  practically,  only  by  the  ingenuity  of  the 
projectors  of  the  enterprise  and  the  objects  which  they 
may  have  in  view. 

Voting  trusts. — It  often  happens  that  conditions  arise 
which  make  it  desirable  or  even  necessary  to  place  the 
control  of  a  corporation  in  the  hands  of  an  agreed-upon 
management  for  a  given  period,  usually  for  a  number  of 
years,  in  order  that  some  policy  or  undertaking  may  be 
consistently  carried  out  or  brought  to  completion  without 
the  risk  involved  in  a  change  of  administration.     This  is 


ii6  PRINCIPLES  OF  BUSINESS 

frequent!}"  the  case  when  the  reorganization  of  a  company 
is  undertaken  by  a  banking  house.  The  bankers  are 
anxious  to  provide  for  a  management  that  will  insure  the 
success  of  the  reorganized  company,  for  their  reputation 
as  well  as  their  profit  is  at  stake.  The  bankers,  however, 
do  not  ordinarily  have  a  controlling  interest  in  the  com- 
pany. A  voting  trust  is  therefore  formed,  under  which 
the  stockholders  of  the  company  deposit  their  stock  with 
trustees  (who  in  this  case  would  be  nominated  by  the 
bankers),  giving  them  the  right  to  vote  the  stock  and  col- 
lect the  dividends  on  it.  The  trustees  in  turn  issue  vot- 
ing trust  certificates  to  the  stockholders,  and  pay  over  to 
the  holders  of  these  certificates  the  dividends  collected  on 
the  stock.  Now  the  bankers  are  assured  of  control  and 
of  a  management  satisfactory  to  themselves. 

Voting  trusts  are  useful  also  in  establishing  a  manage- 
ment for  a  term  of  years  in  accordance  with  an  organiza- 
tion agreement.  In  other  cases  they  may  be  used  to  give 
creditors  of  a  corporation  temporary  control  in  order  to 
avert  the  necessity  of  their  instituting  foreclosure,  insolv- 
ency or  bankruptcy  proceedings. 

Usually,  the  law  requires  that  a  voting  trust  agreement 
be  limited  to  a  reasonable  time; that  all  stockholders  of  the 
corporation  be  permitted  to  join ;  and  that  it  be  for  a  legal 
purpose.  A  voting  trust,  for  example,  in  which  the 
stockholders  of  several  competing  companies  turned  their 
stock  over  to  the  same  trustees,  enabling  them  to  elimi- 
nate competition  and  form  a  monopoly,  would  be  illegal 
and  void. 

Consolidations, — Two  or  more  corporations  may  com- 
bine into  one  larger  concern.     By  an  amalgamation,  com- 


FORMS   OF  BUSINESS  ENTERPRISES      117 

panics  A  and  B,  for  example,  may  form  corporation  C. 
By  a  merger,  they  may  effect  the  same  purpose — continu- 
ing one  of  the  corporations  under  its  old  name  and  merg- 
ing the  other  into  it.  A  merger  would  be  more  desirable 
than  an  amalgamation  if  the  continuing  corporation  had 
a  valuable  good-will  based  on  its  advertised  name.  When 
the  companies  are  combined  in  this  way,  the  new  company 
succeeds  to  all  the  rights  and  obligations  of  the  old  com- 
panies. 

Another  method  of  accomplishing  the  combination  of 
two  corporations  is  that  by  which  one  corporation  pur- 
chases the  entire  assets  of  the  other,  paying  for  the  same 
usually  in  the  stock  of  the  purchasing  corporation.  This 
stock  may  then  be  turned  over  to  the  shareholders  of  the 
selling  corporation — which  then  goes  out  of  existence — 
or,  if  it  appears  desirable  to  keep  the  corporation  in  exist- 
ence, the  stock  received  by  the  corporation  in  exchange 
for  its  assets  may  be  held  by  the  corporation  itself,  in 
which  case  any  dividends  received  on  the  so-acquired 
stock  would  be  distributed  to  the  stockholders  of  the  cor- 
poration as  if  they  had  been  ordinary  profits  from  opera- 
tion. Sometimes,  instead  of  purchasing  the  assets,  one 
corporation  may  lease,  usually  for  a  long  term  of  years, 
the  entire  property  of  another,  paying  therefor  a  specified 
amount,  or  more  usually  a  guaranteed  dividend  on  the 
stock  of  the  lessor  corporation. 

Consolidation  through  stockholding. — The  opera- 
tions of  two  or  more  companies  may  be  combined  by 
placing  the  controlling  interest  of  each  corporation  in 
common  hands.  This  is  accomplished  by  placing  the 
ownership  of  a  majority  of  the  stock  of  each  company  in 


ii8  PRINCIPLES    OF   BUSINESS 

the  hands  of  an  individual,  a  group  of  individuals,  or 
more  usually,  a  holding  company.  The  holding  com- 
pany is  a  corporation  organized  for  the  express  purpose 
of  owning  stock  in  other  corporations.  It  will  buy  a  con- 
trolling interest,  usually  a  majority  of  the  stock,  of  two 
or  more  corporations.  It  may  pay  for  this  stock  by 
issuing  its  own  stock;  or  if  this  cannot  be  successfully 
accomplished,  it  will  pay  in  cash  obtained  from  the  sale 
of  its  own  stock.  Having  secured  control  of  the  several 
corporations,  the  holding  company  will  elect  a  majority 
of  the  directors  of  each  controlled  corporation.  It  is  then 
in  a  position  to  direct  the  activities  of  the  constituent  com- 
panies along  the  lines  of  common  interest.  Thus,  al- 
though the  controlled,  or  subsidiary,  corporations  are  pre- 
served as  going  concerns,  the  wastes  of  competition  are 
avoided  and  all  the  advantages  of  consolidation  are  ob- 
tained. 


BIBLIOGRAPHY 

Gcrstenbcrg,  C.  W.,  Syllabus  of  Prk'ate  Finance,  ch.  II — VI. 

Wrightiiigton,   S.   R.,    Unincorporated  Associations. 

Conyngton,  T.,  Corporate  Oryanization  and  Management. 

Gerstenberg,  C.  W.,  Materials  of  Corporation  Finance,  pp.  1-171, 
1011-1017. 

Lough,  W.  H.,  Business  Finance,  ch.  II-V. 

Lj'on,  \V.  H.,  Capitalization,  ch.  I. 

Sears,  J.  H.,    Trust  Estates  as  Business  Companies. 

Meade,   E.   S.,  Corporation  Finance,  ch.   I  II-V. 

Greene,  T.  L.,  Corporation  Finance,  ch.  II. 

Brown-Green  Company,  Where  and  Hoxv. 

Thompson,  Guy  A.,  Business  Trusts  as  Substitutes  for  Business 
Corporations. 

Haney,    L.   H.,   Business   Organization  and   Combination. 


CHAPTER   VII 


FINANCING 

Importance  of  correct  methods   of  finance. — The 

strength  of  a  chain  is  its  weakest  Hnk.  On  this  principle 
it  can  be  predicated  that  no  one  function  of  business  is 
more  important  than  the  others.  But  at  the  same  time, 
it  cannot  be  denied  that  some  parts  of  the  business  ma- 
chine are  more  intimately  associated  with  the  success 
of  the  enterprise  than  are  others.  Thus  selling  faults 
may  be  localized  and  remedied,  for  if  goods  are  not  sold 
production  can  go  forward  and  goods  may  be  piled  up 
till  a  new  selling  device  or  staff  begins  to  move  them. 
But  financing  affects  all  parts  of  the  business  and  must 
be  done  right  to  keep  them  moving  smoothly.  The  rela- 
tion which  finance  bears  to  the  other  functions  may  be 
illustrated  by  the  following  diagram : 

PRODUCTION  MARKE7ING   FWANCE 


riENENTS    PROCESSES  PRODUCTS  DISTMBUTION 


mm\m 


DdMCIIVE 


GOODS    liWOfflllOH 


JK  c  c  o  1-7  ^J  T  s 


U       M &- 


^  ,  J^ATERIfltS 


STATISTICS 


Li^50R 


MANUFACTURli  5EBV1CD 


5EUNG 


Chart   showing  how    funds  carry  the  business   processes 
to  eventual  distributive  shares  to  owners  and  creditors. 

119 


S7T/JKKfI0ZC>£/a^ 
CJf£D!TS^3 


5J> 


I20  PRINCIPLES  OF  BUSINESS 

PROMOTING  AN   ENTERPRISE 

Promotion. — The  subject  of  promotion  is  usually  con- 
sidered a  financial  problem,  though,  as  we  shall  see, 
financing  is  really  only  a  part  of  the  problem  of  promo- 
tion. By  promotion  is  meant  the  conception  and  organ- 
ization of  a  new  business  or  combination  of  businesses. 
The  first  step  in  promotion  is  conception  or  discovery. 
The  discovery  may  consist  of  the  invention  of  a  new 
process  or  a  new  device,  the  idea  of  supplying  of  some 
old  social  want  in  a  cheaper  way,  or  the  saving  of  costs 
by  combining  old  established  units  of  business.  To  be 
sure,  businesses  are  frequently  promoted  that  have  none 
of  these  economic  justifications,  as  where  a  retail  mer- 
chant's clerk  opens  a  competing  store  even  though  his 
employer  has  not  made  a  fortune  when  enjoying  a  limited 
monopoly.  The  fact  is  that  promoters  concern  themselves 
chiefly  with  private  profit  and  consult  social  welfare  only 
to  the  extent  that  it  is  necessary  to  determine  from  its 
demands  the  likely  success  of  the  contemplated  venture. 
Fortunately,  public  welfare  and  private  gain  run  parallel 
most  of  the  time,  and  one  who  seeks  to  promote  the  one 
will  ordinarily  achieve  the  other. 

Too  much  monopoly  and  too  much  competition  are 
injurious,  the  one  for  the  public  and  the  other  for  the 
competitors.  But  aside  from  the  regulation  of  the  gov- 
ernment, there  are  inherent  forces  that  in  each  of  these 
forms  of  anti-social  business  operations  tend  to  correct 
their  own  evils.  Thus  monopoly  gains  tend  to  invite 
competition,  and  severe  competition  tends  to  eliminate 
the  weaker  competitors.     So  business  at  any  time  and 


FINANCING  121 

place  constantly  see-saws  back  and  forth  from  few  com- 
petitors to  many  competitors  and  seeks  to  find  that  state 
of  equilibrium  in  which  public  welfare  and  private  profit 
will  in  the  aggregate  bulk  up  to  the  largest  possible 
quantity. 

This  argument  in  general  is  the  one  that  the  promoter 
must  understand  before  he  undertakes  to  establish  a  new 
business.  He  will  probably  not  look  at  it  in  just  the 
way  we  have  expressed  it;  his  calculations  will  all  be 
in  terms  of  dollars  and  cents,  of  income  and  outgo,  but 
his  calculations  will  be  affected  by  the  broader  principle 
we  have  outlined. 

Promoter's  calculations. — Let  us  see  just  how  a  pro- 
moter goes  about  his  work.  He  has  conceived  a  new 
idea,  say  a  new  adding  machine.^  He  must  first  calculate 
how  much  money  will  be  required  to  put  his  machine  on 
the  market  and  estimate  whether  or  not  the  pfofits  will 
warrant  the  investment  of  money  and  effort.  His  prob- 
lem may  be  stated  briefly  as  follows :  Can  I  take  in 
enough  money  from  the  sale  of  my  machines  to  pay  for 
(a)  making  and  selling  them,  and  to  pay  (b)  a  reason- 
able return  on  the  money  invested  in  the  business  besides 
leaving  (c)  a  fair  amount  of  profit.  To  discover  how 
much  money  can  be  taken  in  the  promoter  will  have  to 
make  a  study  of  the  possible  market  and  will  do  well  to 
engage  the  services  of  a -market  analyst,  or  at  least  to 

^  We  seem  in  the  text  to  make  the  inventor  of  the  machine  the 
promoter.  In  truth  these  two  functions  of  invention  and  promotion 
call  for  personal  qualities  that  are  seldom  united  in  the  same  person, 
and  the  promoter  therefore  is  likely  to  be  a  person  who  discovers 
not  the  invention  but  the  inventor.  For  a  general  discussion  of 
this  point,  see  Taussig's  Inventors  and  Money-Makers,  and  Som- 
bart'5  Ouintessence  of  Capitalism. 


122  PRINCIPLES  OF  BUSINESS 

get  the  aid  of  people  experienced  in  the  general  line  in 
which  he  is  to  launch  his  enterprise.     Rough  guesses  will 
not  do  and  are  not  necessary.     To  ascertain  fact  (a)  he 
will  have  to  make  a  close  study  of  all  manner  of  op- 
erating costs.     Fact  (b)  is  derived  from  an  estimate  of 
the  probable  amount  of  capital  required  to  put  the  busi- 
ness in  operation,  including,  as  is  shown  in  a  following 
paragraph,  money  for  promotion  expenses,  for  jfixed  cap- 
ital and  for  establishing  the  business  as  well  as  for  a 
permanent  working  fund.     His  calculations  in  their  most 
familiar  form  may  be  arranged  as  follows : 
Gross  Income 
Less     Operating  Expenses 
Leaving     Net  Income 

Less     Interest  on  Capital  Raised 
Leave     Profits 

Estimating  gross  income. — So  important  is  each  of 
the  items  entering  the  calculations  of  the  promoter  that 
we  had  better  consider  each  separately  though  briefly. 

Gross  income  is  calculated  generally  on  the  basis  of 
some  statistical  unit — thus  an  annual  income  of  $2.50 
per  capita  of  population  of  the  territory  served  in  the 
case  of  a  small  gas  company;  the  sale  of  one  office 
device  per  100  banks  in  the  country,  and  otlier  like  units. 
Let  it  be  understood  that  these  estimates  are  not  easy 
to  make  and  tliat  they  require  careful  collection  of  facts 
and  close  analysis.  Mere  guesses  are  too  dangerous.  And 
in  any  event  consideration  must  be  given  not  only  to 
present  conditions,  but  to  future  changes  and  potential- 
ities as  well. 

Calculating  operating  expenses. — Experience  in  the 


FINANCING  12.^ 

same  line  of  business  is  quite  essential  to  approximate  the 
probable  operating  expenses.  In  the  first  place,  it  is 
necessary  to  include  all  expenses — production,  selling, 
general  administration,  up-keep  and  contingencies. 

Moreover,  it  must  be  remembered  that  operating  ex- 
penses do  not  vary  directly  with  variations  in  the  gross. ^ 
General  administration,  for  example,  is  likely  to  cost  a 
certain  sum  whether  a  thousand  articles  are  sold  a 
month  or  twelve  or  fifteen  hundred.  For  this  reason 
operating  expenses  are  likely  to  ho.  relatively  high"  while 
the  projected  concern  is  young. 

Estimating  the  capital  expenses. — The  promoter 
then  calculates  the  amount  of  money  that  will  be  re- 
quired to  start  his  enterprise  as  a  money-making  propo- 
sition. He  will  require  money  for  the  following  pur- 
poses : 

1.  Promotion. 

2.  Construction. 

3.  Building  up  the  business. 

The  promotion  expenses  may  be  small  or  large,  de- 
pending on  the  business.     In  general  it  may  be  stated 

^Ripley,  in  his  Railway  Rates  and  Regnlaiion,  p.  55,  estimates 
that  about  45  per  cent  of  railway  expenses  vary  with  the  gross 
and  that  the  rest  are  quite  stationary. 

2The  ratio  of  operating  expenses  to  gross  revenue  is  called  the 
operating  ratio.  It  is  a  statistical  unit  of  much  value,  since  it  indi- 
cates operating  efficiency.  If  railroad  A,  for  example,  has  an 
operating  ratio  of  65  per  cent  and  railroad  B  has  an  operating  ratio 
of  80  per  cent,  the  former  is  quite  likely  to  be  the  more  efficiently 
operated.  To  be  sure,  there  may  be  other  circumstances  that  would 
make  such  a  deduction  quite  erroneous.  Thus,  if  we  think  of 
these  two  roads  as  ordinary  manufacturing  companies,  and  if  B 
has  a  much  smaller  capital  invested  in  its  plant  than  A,  it  is  likely 
that  A  has  a  small  operating  expense  because  it  is  using  machinery 
whose  decrease  in  operating  expense  may  be  offset  by  large  fixed 
charges  or  by  large  requirements  for  dividends. 


124  PRINCIPLES  OF  BUSINESS 

that  the  broader  the  plan  and  the  larger  the  profits  ex- 
pected, the  greater  will  be  the  promotion  expense.  In 
some  businesses  promotion  expense  is  the  largest  money- 
cost.  There  is  practically  no  construction,  and  the  busi- 
ness quickly  establishes  itself  after  the  promotion  has 
been  carried  out.  Take  the  promotion,  for  example,  of 
several  successful  competing  plants.  The  promoter  will 
be  required  to  visit  the  plants'  owners,  to  get  a  state- 
ment of  the  plants'  affairs  and  to  negotiate  the  terms 
of  the  combination.  He  may  be  required  to  engage  the 
services  of  expert  accountants,  appraisal  engineers  and 
lawyers.  But  after  all  this  work — this  promotion  work 
— has  been  done  and  the  ownership  interests  are  read- 
justed, the  business  goes  on  without  additional  financ- 
ing.^ The  same  observations  hold  true  where  a  busi- 
ness plans  to  have  its  product  manufactured  and  to  use 
established  agencies  for  selling  them. 

Promotion  expenses. — Promotion  expenses  of  a  new 
concern  consist  largely  of  the  money  spent  by  the  pro- 
moter in  assembling  the  units  of  his  future  business. 
He  may  be  required  to  investigate  patents,  to  calculate 
the  possibilities  of  the  new  venture,  to  find  the  means 
of  manufacturing,  to  get  the  manufacturing,  whether  by 
the  new  business  itself  or  by  some  outside  concern, 
planned  and  arranged  for,  to  get  the  selling  department 
arranged  and  to  plan  the  means  for  raising  ail  the  neces- 

1  Additional  financing  may,  of  course,  and  frequently  does  enter 
into  the  promotion,  but  not  necessarily.  Combinations  have  required 
working  capital  because  the  constitutent  companies  have  been 
stripped  of  working  capital  by  their  owners  as  a  step  preliminary 
to  consolidation.  For  an  example,  see  Gerstenberg's  Materials  of 
Corporation  IHnancc,  p.  538,  and  notice  that  the  assets  taken  over 
do  not  include  cash  or  accounts  receivable.  See  also  pp.  489-495 
ior  a  statement  of  the  costs  of  promoting  a  consolidation. 


FINANCING  125 

sary  funds.  The  expense  of  doing  all  this  will  likely  be 
met  by  the  promoter  himself,  though  he  will  undoubtedly 
reimburse  himself  later  by  taking  from  the  concern  some 
form  of  capital  obligation,  usually  common  stock. 

Construction  expenses. — In  the  case  of  a  new  manu- 
facturing concern,  such  as  one  to  make  and  sell  an  add- 
ing machine,  the  cost  of  getting  the  plant  and  its  equip- 
ment must  be  estimated  and  the  amount  of  funds  neces- 
sary to  procure  them  must  be  raised.  In  estimating  the 
capital  requirements  care  must  be  taken  to  include  not 
only  the  cost  of  the  assets  themselves,  but  the  expense  of 
putting  them  in  place,  and  an  allowance  should  always 
be  made  for  contingencies.  Moreover,  while  this  is  be- 
ing done  the  business  organization  will  have  to  be  built 
up  and  the  cost  of  assembling  and  maintaining  the  or- 
ganization will  have  to  be  met  out  of  capital  till  revenue 
from  current  operations  can  produce  the  necessary  in- 
come. 

Assembling. — After  the  promoter  has  "discovered" 
his  project — discovery  including  such  preliminaries  as 
investigating  it  to  see  how  much  money  will  be  required 
to  start  it  and  to  operate  it,  and  how  much  money  it  is 
likely  to  bring  in — the  promoter  will  be  ready  to  take  the 
next  step  in  promotion,  viz.,  "assembling."  By  assem- 
bling is  meant  the  bringing  together  of  the  various  ele- 
ments that  will  enter  the  completed  operating  concern. 
For  example,  if  a  patent  is  to  be  promoted,  the  first 
problem  is  to  see  if  the  patent  is  valid,  as  well  as  com- 
mercially valuable.  The  next  step  is  to  get  control  of 
the  patent  and  to  get  the  proper  kind  of  men  to  make 
and  sell  the  patented  article.    If  we  take  a  more  complex 


126  PRINCIPLES  OF  BUSINESS 

problem  like  the  promotion  of  an  interurban  electric 
railway,  the  difficulties  will  be  greater.  Franchises, 
rights  of  way,  contracts  for  construction,  contracts  of 
employment  of  managers  will  all  have  to  be  obtained  or 
proven  obtainable  before  capitalists  will  take  any  interest 
in  looking  over  the  scheme.  Where  the  promotion  con- 
sists of  the  consolidation  of  several  companies,  option 
agreements,  agreements  to  consolidate,  or  purchase  agree- 
ments will  be  necessary.  Oftentimes  the  promoter  will 
spend  much  time  and  effort,  as  well  perhaps  as  a  con- 
siderable sum  of  money  for  expenses,  in  getting  these 
various  agreements.  He  must  act  circumspectly  in  pre- 
senting his  proposition  to  prospective  capitalists,  for  if 
the  latter  are  unscrupulous  they  may  go  to  the  various 
concerns  about  to  be  consolidated  and  deal  with  them 
directly,  thus  leaving  the  promoter  out  in  the  cold.  In 
such  a  case  the  promoter's  work  will  have  made  the  con- 
solidation easy  for  the  capitalists,  for  he  will  have  per- 
suaded the  concerns  to  agree  to  the  consolidation.  In- 
deed, his  engineers  and  accountants  may  have  figured 
out  what  the  various  plants  are  worth  and  their  calcu- 
lations may  be  accepted  as  the  basis  of  consolidation, 
though  the  capitalists,  being  unscrupulous,  will  seek  to 
avoid  reimbursing  the  promoter  for  his  actual  money 
outlay  or  compensating  him  for  his  time  and  trouble. 
Much  less  will  they  give  him  a  reasonable  promoter's 
profit  for  what  he  had  accomplished  before  the  matter 
was  brought  to  the  attention  of  the  capitalists.  To  pro- 
tect himself  from  such  a  situation  the  promoter  must 
see  that  his  contracts,  including  his  contracts  with  the 
prospective  capitalists,  are  all  carefully  drawn.     Thus  it 


FINANCING  127 

will  be  seen  that  assembling  a  proposition  is  not  a  matter 
to  be  considered  lightly. 

After  the  proposition  has  been  discovered  and  assem- 
bled the  promoter  is  ready  to  go  to  the  banker  or  capital- 
ists to  have  it  financed. 

V^ORKING  CAPITAL 

Working  capital. — Given  a  business  machine  com- 
plete in  all  its  parts,  with  every  function  manned  by  com- 
petent men,  there  still  remain  demands  for  funds  neces- 
sary to  put  the  entire  machinery  in  operation  and  to  keep 
it  in  operation  till  the  business  pays  for  itself.  These 
funds  may  be  called  the  initial  working  capital.  By 
working  capital,  as  the  term  is  commonly  used  by  busi- 
ness men,  is  meant  the  net  amount  of  liquid  funds,  con- 
sisting chiefly  of  cash  and  accounts  receivable,  less  the 
amount  of  current  or  liquid  debts — such  debts  as  have 
to  be  met  within  a  reasonably  short  time.  Initial  work- 
ing capital,  it  will  be  seen,  is  somewhat  different.  It 
consists  of  funds  that  will  be  used  in  developing  the  busi- 
ness without  acquiring  any  definite  tangible  asset.  A 
common  business  practice  is  to  keep  an  account  of  money 
spent  in  such  a  way,  and  to  call  it  an  asset  under  the 
name  of  good-will,  going  concern  value,  or  organization 
expense.  Though  the  asset  is  not  very  real,  in  the  sense 
that  it  cannot  be  seen  or  even  very  accurately  estimated 
in  advance,  it  is  nevertheless  a  very  real  cause  for  the 
spending  of  money,  and  the  promoter  who  does  not  pro- 
vide sufficient  funds  for  starting  the  business  and  for 
giving  it  plenty  of  opportunity  to  establish  itself,  launches 
his  craft  without  sails  or  motive  power. 


128  PRINCIPLES  OF  BUSINESS 

Changes  in  working  capital. — After  a  business  is 
started  it  is  always  required  to  keep  on  hand  a  certain 
excess  of  liquid  assets  over  liquid  liabilities.  This  ex- 
cess— working  capital  it  is  called — is  a  contingency  fund 
to  meet  immediate  requirements.  A  concern  such  as  a 
public  utility,  for  whose  products  there  is  a  constant  de- 
mand, and  whose  income  may  be  collected  in  advance  of 
expenditures  or  at  the  same  time  that  they  are  incurred, 
needs  but  little  working  capital.  Thus  it  is  generally 
reckoned  that  a  street  railway  is  safe  if  it  has  sufficient 
working  capital  to  pay  about  from  one  to  two  months' 
operating  expenses. 

Industrials  ordinarily  require  more  working  capital. 
In  any  case,  other  things  being  equal,  the  following  ele- 
ments will  usually  govern  the  comparative  amount  of 
working  capital  required. 

1.  The  larger  business  will  require  more  working 
funds. 

2.  During  a  period  of  rapid  expansion  a  company  will 
require  a  much  larger  supply  of  ready  money,  for  the 
money  it  collects  from  the  sale  of  goods  it  has  manu- 
factured will  ordinarily  be  less  than  the  cost  of  purchas- 
ing and  manufacturing  the  larger  supply  of  goods  neces- 
sary for  its  increasing  business. 

3.  The  company  that  takes  longer  to  manufacture  its 
product  will  require  more  working  capital,  for  it  will 
tie  up  a  large  proportion  of  its  funds  in  semi-finished 
products. 

4.  A  concern  that  makes  various  kinds  of  products 
will  require  more  capital  to  keep  itself  supplied  with  a 
reasonable  stock  of  each  commodity. 


FINANCING  129 

5.  Seasonal  businesses  will  need  a  larger  supply  of 
working  capital  at  one  time  than  at  another. 

6.  The  more  quickly  a  company  can  turn  over  its 
capital  or  merchandise,  the  less  working  capital  it  will 
require. 

7.  The  longer  the  terms  of  credit  a  concern  extends 
to  its  customers  the  greater  the  amount  of  working  capi- 
tal it  will  need. 

8.  The  longer  the  terms  of  credit  it  can  obtain  in  pur- 
chasing supplies,  the  less  the  amount  of  capital  it  will  find 
necessary. 

9.  Greater  difficulty  in  securing  raw  materials  calls 
for  greater  working  capital,  for  in  such  a  case  a  con- 
cern must  anticipate  its  requirements  and  lay  in  a  stock 
of  raw  materials  and  pay  for  them  long  before  they  are 
sold. 

Estimating  the  initial  working  capital  require- 
ments.— We  have  seen  that  at  the  outset  the  company 
needs  funds  not  only  to  acquire  its  fixed  assets  but  to 
get  its  business  started.  For  example,  suppose  that  a 
company  manufacturing  typewriters  and  selling  them  on 
installment  payments  will  be  able  to  sell  100  machines 
the  first  month,  200  machines  the  second  month,  and 
thereafter,  300  machines  a  month.  The  entire  cost  of 
making  the  machines  is  $20  a  machine  and  the  adminis- 
tration expenses  are  $2,500  a  month,  the  machines  selling 
for  $100  each,  payable  $20  down  and  $10  a  month.  An 
estimate  of  the  amount  of  funds  that  will  be  required 
to  get  the  business  to  the  point  where  the  cash  income 
is  sufficient  to  take  care  of  the  cash  outgo  may  be  made  as 
follows  • 


I30  PRINCIPLES  OF  BUSINESS 

1st  month  zd  month  3d  month  4th  m,onth 

G)st  of  machines $2,000  $4,000  $6,000  $6,000 

Administration        ex- 
penses           2,500  2,500  2,500  2,500 

Total  outgo  $4,500  $6,500  $8,500  $8,500 

Initial    payments 2,000  4,000  6,000  6,000 

Installments     1,000  3,000  6,000 

Total  cash  income $2,000  $5,000  $9,000  $12,000 

Net   income    (cash) .  .—$2,500        — $1,500  $500  $3,500 

Thus  it  will  be  seen  that  the  company  will  have  a 
net  cash  outgo  for  the  first  two  months  only/  and  that 
if  it  provides  itself  with  $4,ocK)  at  the  outset  it  will 
likely  have  sufficient  cash  to  get  started.  It  ought  to  be 
pointed  out,  however,  that  in  practice  a  number  of  heavy 
initial  expenses  would  have  to  be  added  to  the  outgo 
of  the  first  few  months,  among  them  being  the  cost  of 
advertising,  of  arranging  agencies,  of  finding  salesmen, 
training  them,  and  the  like.  Moreover,  in  spite  of  care- 
ful planning  from  an  engineering  standpoint,  both  the 
plant  and  the  product  will  probably  need  much  readjust- 
ing or  "tuning  up"  in  the  light  of  actual  experience  in 
operation.  All  this  costs  money  and  adds  nothing  to  the 
visible  assets.  Since  the  company  will  have  insufficient 
operating  revenue  to  meet  these  costs,  they  will  per- 
force be  met  from  capital  funds,  i.e.,  funds  acquired 
through  the  sale  of  stock  or  bonds  or  furnished  out  of 

^  Note  that  while  the  company  has  a  net  cash  outgo  of  $4,000 
during  the  first  two  months,  it  actually  makes  a  profit  of  $19,000. 
This  is  figured  as  follows:  Sold  300  machines  at  $100  each  =  $30,000 
gross  income  ($7,000  received  in  cash,  and  $23,000  represented  by 
accounts  receivable).  Deduct  $11,000  operating  expenses  ($6,000 
being  the  cost  of  the  machines  and  $5,000  being  the  administration 
expenses)  and  we  have  left  a  profit  of  $19,000.  Of  course,  it  would 
be  more  conservative  to  deduct,  from  this  profit,  a  reserve  for  bad 
debts  and  for  the  expense  of  collecting  the  outstanding  accounts 
receivable. 


FINANCING 


131 


the  capital  of  the  proprietors,  and  the  company  will  con- 
sequently treat  these  costs,  at  least  temporarily,  as  a 
capital  asset  under  the  name  of  good-will,  organization 
expenses,  patents  or  the  like.  Conservative  practice, 
however,  looks  upon  these  expenditures  as  deferred 
charges  to  operation,  and  consequently  the  capital  assets 
are  reduced  in  value  on  the  books  from  time  to  time  by 
making  a  credit  to  them  and  charging  profit  and  loss. 

Seasonal  variations  in  working  capital. — Many  con- 
cerns, and  especially  the  trading  companies,  have  at 
certain  periods  of  the  year  a  larger  demand  for  work- 
ing capital  than  at  other  times.  Such  concerns  keep  on 
hand  a  certain  amount  of  owned  working-capital  in  or- 
der to  keep  their  credit  good,  and  then  borrow  from 
banks  the  additional  capital  required  seasonally.  The 
principle  may  be  represented  graphically  in  the  diagram 
given  below : 


*&/j.      Fei     liar    Apr    Jfat/     June    Juli/     Aug    iSepi    Ocf.      Mr    Dec     Jan 

The  months  are  divided  off  on  the  horizontal  lines 
A-B,   A'-B'.     Distance  A- A'  is  the  amount  of   owned 


132  PRINCIPLES  OF  BUSINESS 

working-capital  and  the  distance  A'-R  the  total  amount 
of  borrowed  working-capital.  The  curved  line  C,  E,  F 
represents  the  purchases  of  the  concern  and  the  curved 
line  F,  G,  H  represents  the  course  of  sales  or  diminish- 
ing stock  of  goods.  The  line  M,  Q,  P,  N  represents  the 
course  of  income  from  sales,  the  income  being  used  for 
gradually  reducing  the  loans.  When  the  income  reaches 
Q,  the  firm's  own  capital  will  have  been  brought  back 
into  the  concern,  and  when  the  point  P  is  reached  the 
borrowed  working-capital  will  also  be  returned.  The 
distance  ON  represents  the  profits  on  the  transaction 
which  we  may  assume  are  paid  out  in  dividends,  thus 
bringing  the  company  back  to  where  it  was  at  the  begin- 
ning of  the  year.  It  is  now  ready  to  start  the  same  cycle 
over  again. 

OBTAINING  pAPITAL  FOR  EXPANSION 

Capital  for  expansion. — It  is  a  rule  of  all  life  that 
an  organism  or  an  organization  never  stands  still.  It 
either  moves  forward  or  moves  backward.  The  process 
of  expansion  may  be,  and  generally  is,  gradual,  but  there 
usually  are  steps  in  the  expansion  that  call  for  some  form 
of  new  financing.  The  gradual  expansion  usually  is 
worked  out  by  retaining  some  of  the  profits  in  the  busi- 
ness. For  a  while  some  of  the  profits  will  be  used  to 
purchase  new  machinery,  to  increase  the  number  of 
agencies,  and  the  like.  Then  perhaps  will  come  a  time 
when  new  buildings  or  large  amounts  of  new  equipment 
will  be  required,  for  the  purchase  of  which  a  part  of  the 
profits  of  the  business  will  be  inadequate.  This  means 
that  the  company  will  have  to  obtain  a  definite  amount 


FINANCING  133 

of  new  capital.     It  may  borrow  this  new  capital,  or  it 
may  raise  the  money  by  selHng  additional  stock. 

Selling  additional  stock. — If  the  company  is  doing 
a  profitable  business,  and  is  distributing  fairly  large  divi- 
dends to  its  stockholders,  its  old  stock  usually  will  be 
worth  more  than  its  nominal  or  par  value.  In  such  a 
case,  it  will  be  comparatively  easy  for  the  company  to 
sell  additional  new  stock  at  par,  or  even  at  a  premium. 
Should  it  desire  to  do  this,  the  corporation  will  offer 
the  new  stock  to  the  old  stockholders,  for  not  only  are 
the  old  stockholders  the  most  likely  purchasers  of  the  new 
stock,  but  they  have  a  legal  right  to  purchase  the  stock  be- 
fore it  may  be  offered  to  outsiders.  This  is  because  each 
stockholder  has  the  right,  if  he  so  desires,  to  retain  his 
proportionate  control  in  the  corporation.  Each  stock- 
holder will  therefore  usually  be  given  a  negotiable  cer- 
tificate showing  his  right  to  subscribe  to  his  proportion- 
ate share  of  the  new  stock  at  a  price  fixed  by  the  cor- 
poration. If  this  price  is  sufficiently  less  than  the  market 
price  of  the  old  stock,  as  is  usually  the  case,  the  right 
could  easily  be  sold  by  the  stockholders  to  outsiders  for 
whatever  it  is  worth.  On  the  other  hand,  if  the  old 
stock  were  selling  below  par  and  the  new  stock  were 
offered  at  par,  it  is  obvious  that  the  right  to  subscribe 
to  it  would  have  no  value.  Indeed,  in  such  a  case,  this 
method  of  financing  would  not  be  open  to  the  corporation, 
for  no  one  would  pay  $100  a  share  for  new  stock  of  a 
company  whose  stock  at  present  outstanding  is  selling, 
let  us  say,  at  $80.  But  the  corporation  might,  with  the 
consent  of  the  stockholders,  create  an  issue  of  preferred 
stock  with  a  large  enough  preference  as  to  dividends  to 


134  PRINCIPLES  OF  BUSINESS 

insure  a  ready  market  for  it  above  par.  Or  the  com- 
pany might  borrow  the  necessary  funds,  issuing  its  bonds 
to  the  lenders. 

BORROWING  CAPITAL 

Borrowing  funds. — One  reason  that  will  prompt  an 
established  corporation  to  borrow  has  been  pointed  out 
in  the  preceding  paragraph — the  corporation  finds  this  a 
convenient  way  of  raising  money.  But  there  is  a  more 
important  reason  why  corporations — and  for  that  matter 
individuals  as  well — borrow  funds.  Borrowing  enables 
the  owner  to  magnify  his  profits — although  by  borrowing 
the  owner  takes  a  risk  and  may  magnify  his  losses.  To 
illustrate,  suppose  that  a  company  with  a  capital  of 
$100,000  is  earning  10  per  cent  on  this  amount  and  that 
its  earnings  on  a  larger  amount  would  be  at  the  same 
rate;  if  it  borrows  another  $100,000  at  five  per  cent,  the 
company  will  make  $20,000  (gross)  less  $5,000  paid  in 
interest,  or  $15,000  net — which  will  give  the  company  15 
per  cent  instead  of  10  per  cent  on  its  own  capital.  To 
make  this  extra  per  cent  the  company  takes  the  risk, 
which  the  lender  avoids.  Thus,  if  the  company  made 
only  $5,000  instead  of  $20,000  on  the  aggregate  of  owned 
and  borrowed  capital,  it  would  get  absolutely  nothing  for 
its  trouble  and  for  its  own  investment — the  $5,000  would 
all  go  to  the  lender. 

Where  to  borrow. — A  small  merchant  who  wishes  ^•'^ 
borrow  additional  capital  usually  looks  either  to  his 
friends  and  relatives,  or  to  a  commercial  bank.  From 
the  bank,  the  merchant  can  expect  to  obtain  only  a  short- 
term  loan,  that  is,  a  loan  for  three,  six  or  nine  months, 


FINANCING  135 

although  in  many  cases  these  loans  are  renewed  from 
time  to  time  so  that  in  effect  they  become  loans  for  two, 
or  three  or  even  ten  years/  Usually,  however,  the  bank 
will  lend  only  temporary  working  capital  to  a  merchant, 
to  enable  him  to  finance  the  purchase  or  manufacture  of 
merchandise  until  such  time  as  it  is  sold  to  and  paid  for 
by  customers  of  the  merchant.  Moreover,  a  bank  will 
lend  money  only  to  a  merchant  who  can  measure  up  to 
high  credit-standards;  he  must  be  able  to  furnish  either 
good  collateral  or  a  financial  statement  showing  a  sound 
condition. 

The  small  merchant  may  also  look  to  his  supply  houses 
for  some  of  his  capital.  They  will  sell  him  the  goods 
he  requires  on  credit,  and  thus  in  effect  lend  him  part  of 
his  business  capital  temporarily. 

If  the  small  merchant  wants  to  borrow  money  for  a 
year  or  more,  he  generally  can  look  only  to  his  friends 
or  relatives,  although,  as  we  pointed  out  above,  bank 
loans  are  often  renewed  so  many  times  that  they  in  effect 
become  loans  for  several  years.  Indeed,  if  the  merchant 
owns  marketable  securities,  he  will  find  it  comparatively 
easy  to  renew  a  loan  secured  by  that  collateral.  If  he 
owns  real  property,  he  can  borrow  money  from  a  sav- 
ings bank,  an  insurance  company  or  an  individual  for 
one  to  five,  ten  or,  in  some  cases,  twenty  years,  mort- 
gaging the  property  as  security  for  the  loan.  In  the 
same  way,  fixtures  and  machinery  used  in  the  business 
might  be  pledged  for  a  six-months'  or  a  one-year's  loan. 

The  larger  merchant  not  only  has  all  of  these  sources 

^See  H.  G.  Moulton,  "Commercial  Banking  and  Capital  Forraa- 
fJ-^  "  (nwnal  of  Political  Economy,  May,  Jmie,  July,  1918. 


136  PRINCIPLES  OF  BUSINESS 

of  funds  open  to  him,  but  others  as  well.  Thus,  he  may 
borrow  money  from  a  discount  house  by  pledging  his 
accounts  receivable  as  collateral.  This  practice,  however, 
is  not  looked  upon  with  favor  by  credit  men  and  bankers, 
and  it  is  usually  a  very  expensive  method  of  raising  funds. 
It  is  better  and  cheaper  to  borrow  from  banks,  and  in 
doing  so  the  large  merchant  may  often  borrow  even  more 
cheaply  by  selling  his  promissory  notes,  through  note- 
brokers,  to  banks  in  different  parts  of  the  country.  He 
will  find  in  practically  any  large  city  one  or  more  indi- 
viduals or  firms  who  do  a  specialized  business  as  note- 
brokers. 

Borrowing  from  the  investors. — The  larger  corpora- 
tions, joint-stock  companies  and  Massachusetts  trusts 
have  a  much  wider  market  in  which  to  borrow  their 
funds.  They  are  not  confined  to  dealings  with  friends, 
creditors,  banks,  discount-houses  and  note-brokers.  They 
borrow  as  well  from  the  general  investing  public,  by 
issuing  bonds  or  notes  and  selling  them — usually  to  in- 
vestment bankers;  of  whom  we  shall  shortly  say  more. 
The  investment  brokers,  in  turn,  sell  the  securities  to  the 
public. 

FINANCING  THROUGH  BOND  ISSUES 

Choice  of  bonds. — Two  influences  will  be  brought  to 
bear  when  a  company  contemplates  the  issuance  of  bonds. 
On  the  one  hand,  the  company  will  desire  to  give  as 
little  as  possible ;  on  the  other  hand,  the  prospective  bond- 
holders will  desire  to  get  as  much  as  possible.  In  the  long 
run,  the  kind  of  bond  that  will  be  issued  will  depend 
largely  on  the  credit  of  the  company  and  the  general 


FINANCING  137 

business  and  financial  conditions  that  exist  at  the  time 
the  securities  are  brought  out.  A  sound  concern,  in 
normal  times,  will  be  able  to  issue,  perhaps,  an  unsecured 
obligation — a  so-called  debenture  bond/  Moreover,  the 
rate  of  interest  will  probably  be  low.  In  abnormal  times 
the  same  corporation  might  have  to  offer  some  security 
— that  is,  give  a  mortgage  to  secure  the  bonds,  and-  cer- 
tainly would  have  to  pay  a  high  rate  of  interest.  Ordi- 
narily the  security  would  be  given  in  order  that  the  rate 
of  interest  demanded  by  the  bondholders  would  be  as  low 
as  possible."  As  to  whether  a  mortgage  should  be  given 
or  not,  the  rate  of  interest  that  will  have  to  be  paid  ought 
not  to  be  the  determining  factor.  There  is  a  principle, 
familiar  to  card  players,  "keep  your  trumps  to  the  last." 
And  so  in  finance  there  is,  or  ought  to  be,  a  principle, 
"keep  your  best  security  till  the  last — till  it  may  be  really 
needed  in  some  period  of  stress." 

The  corporate  mortgage. — This  last-mentioned  prin- 
ciple has,  however,  been  almost  entirely  neglected  in  prac- 
tice. Corporations  have  in  the  past  sought  to  sell  their 
bonds  as  easily  as  possible,  and  at  as  low  a  rate  of  in- 
terest as  possible.  To  do  this  they  have  mortgaged  not 
only  what  they  have  had  but  what  they  were  to  get  in 
the  future — present  and  "after-acquired"  property.  We 
can  readily  picture  to  ourselves  the  case  of  a  company 
with  a  million  of  clear  assets  placing  an  $800,000 "mort- 
gage on  its  property.     It  then  will  have  an  $800,000 

1  Notice  that  in  England  the  word  "debenture"  is  used  generally 
to  indicate  what  we  mean  when  we  say  "bond."  In  America  a 
debenture  is  an  unsecured  bond. 

-The  bondholders  would,  in  effect,  sacrifice  an  amount  of  income 
to  get  some  degree  of  security.  See  on  this  point  Lyon's  Capitaliza- 
tion, ch.  I. 


138  PRINCIPLES  OF  BUSINESS 

bond-issue  secured  by  $1,800,000  of  property.  The  next 
time  the  company  expands  it  may  need  $1,000,000.  It  is 
readily  conceivable  that  its  property  would  have  grad- 
ually increased  in  value  through  keeping  some  of  the 
profits  in  the  business.  Let  us  suppose  its  balance-sheet 
in  abbreviated  form  is  as  follows : 

Assets  $2,500,000    Stock  $1 ,000,000 

Bonds    800,000 

Surplus  700,000 

$2,500,000  $2,500,000 

The  net  value  of  the  assets  is  $1,700,000.  A  mort- 
gage of  $1,000,000  would  have  relatively  a  better  equity 
back  of  it  than  the  original  mortgage  had  at  the  time 
it  was  issued.^ 

But  under  the  rule  familiar  to  lawyers  that  "prior- 
ity in  time  gives  priority  in  equity,"  the  first  mortgage 
would  be  a  first  lien  on  all  the  property  and  the  second 
mortgage  would  be  a  second  lien. 

Now  finance  is  not  all  a  matter  of  balance  sheets.  The 
order  of  claims  against  the  assets  ordinarily  determines 
the  order  of  claims  against  the  earnings  and  while  the 
assets  appear  to  be  sufficient  to  protect  both  issues  of 
bonds,  there  may  be  some  question  about  the  adequacy  of 
the- net  earnings  to  meet  the  interest  charges  on  both 
issues.    The  second  issue,  therefore,  would  probably  have 

^  The  use  of  the  terms  "equity  behind"  a  mortgage,  and  "security 
behind"  a  mortgage  can  be  understood  from  their  application  to 
the  problem  in  hand.  The  security  behind  the  first  mortgage  bonds 
is  $2,500,000,  and  the  equity  behind  them  is  the  net  value  of  this 
$2,500,000  or  $1,700,000.  If  $1,000,000  is  added  to  the  assets  and 
a  second  mortgage  of  $1,000,000  is  placed  on  the  property,  the 
security  behind  the  first  mortgage  would  be  $3,500,000  and  the 
equity  would  be  the  net  worth  of  that  security  or  $2,700,000.  This 
"equity"  in  turn  would  be  the  "security"  behind  the  second  mort- 
gage, whose  protecting  equity  would  be  the  net  value  of  this  latter 
"security,"  or  $1,700,000. 


FINANCING  139 

to  yield  a  higher  rate  of  interest  than  the  first  in  order 
to  make  up  for  the  risk. 

Modern  bond-financing. — The  difficulty  presented  in 
the  foregoing  section  has  given  rise  to  the  modern  method 
of  creating  large  refunding  issues  of  bonds. 

Suppose  the  company  referred  to  wanted  to  use  the 
$1,000,000  to  acquire  a  plant  of  another  company.  The 
moment  the  plant  was  acquired,  it  would  become  subject 
to  the  lien  of  the  first  mortgage  under  the  provisions  oi 
that  mortgage's  ''after-acquired''  clause.  One  exception 
to  this  rule — and  this  exception  is  made  to  do  yeoman's 
duty — occurs  in  the  case  of  so-called  "purchase  money" 
mortgages.  Thus  if  the  company  acquired  the  plant  from 
Company  B  and  gave  Company  B  a  mortgage  for 
$1,000,000  their  mortgage  would  be  a  first  lien  on  the 
company's  new  property  and  the  other  mortgage,  i.e., 
the  one  first  issued  for  $800,000,  by  virtue  of  its  "after- 
acquired"  clause,  would  be  the  second  lien. 

Instead  of  giving  a  $1,000,000  mortgage  in  payment 

for  the  plant,  the  company — let  us  now  call  it  Company 

A — would   perhaps   create   a   $5,000,000   mortgage   and 

would  call  it  "first  and  refunding."     The  mortgage  then 

would  be  of  the  variety  known  as  "limited  open-end.''  ^ 

1  Corporate  mortgages  are  ordinarily  made  out  to  a  trustee — 
usually  a  trust  company — who  holds  the  mortgage  for  the  benefit  of 
anybody  who  may  become  the  owner  of  one  of  the  bonds  mentioned 
in  the  mortgage.  If  all  the  bonds  are  issued  at  one  time,  the  mort- 
gage is  said  to  be  a  "closed-end"  mortgage.  If  an  indefinite  number 
of  bonds  may  be  issued  from  time  to  time,  the  mortgage  is  said  to 
be  an  "open-end"  mortgage.  If  more  than  the  original  issue  may 
be  made,  but  not  to  exceed  a  stated  amount — in  the  example  above, 
$5,000,000 — the  mortgage  is  a  "limited  open-end"  mortgage.  The 
open-end  and  limited  open-end  mortgages  contain  "restrictions"  or 
"escrow  agreements,"  the  purpose  of  which  is  to  protect  the  bond- 
holders who  already  hold  bonds  from  the  issuance  of  additional 
bonds  under  the  same  mortgage  and  entitled  to  the  same  rights  as 


I40  PRINCIPLES  OF  BUSINESS 

One  million  dollars  worth  of  bonds,  secured  by  this  mort- 
gage, would  be  used  to  acquire  the  new  plant.  Then  a 
part  of  the  bonds,  secured  by  the  same  mortgage,  would 
be  used  to  refund  the  old  $800,000  issue.  Notice  is  sent 
to  the  holders  of  those  old  bonds,  inviting  them  to  ex- 
change their  bonds.  As  the  bonds  are  exchanged,  the 
old  bonds  are  deposited  with  the  trustee  named  in  the 
refunding  issue;  and  to  the  extent,  therefore,  that  the 
old  bonds  are  refunded,  the  new  issue  participates  in  the 
lien  of  the  first  mortgage  on  the  old  property.  Grad- 
ually, as  the  old  issue  is  retired,  the  new  issue  becomes 
a  real  first-mortgage  on  all  the  company's  property. 

Advantage  of  large  issues. — One  great  advantage  of 
a  piece  of  financing  of  this  kind  is  that  it  replaces  small 
underlying  bond  issues  with  one  large  issue,  widely  dis- 
tributed and  well  known.  It  is  easier  for  a  holder  of  a 
bond  secured  by  such  a  mortgage  to  sell  or  hypothecate 
it,  since  there  will  likely  be  frequent  transactions  in  it  on 
the  exchanges  and  its  value  will  therefore  be  well  known. 
This,  and  the  advantage  that  the  refunding  issue  is  likely 
to  be  a  first  lien  on  a  more  important  part  of  the  com- 
pany's property  than  that  covered  by  the  underlying 
mortgage,  is  the  argument  advanced  to  the  old  bond- 
holders to  induce  them  to  exchange  their  old  bonds  for 
the  new  bonds. 

Financing  subsidiaries. — When  one  company  owns 
all  or  practically  all  of  the  stock  of  another  company, 

the  holders  of  the  earlier  issued  bonds  without  in  some  way  adding 
to  the  company's  property  and  earning  power.  Under  various 
modern  mortgages,  bonds  may  be  issued  from  time  to  time  protected 
by  the  same  mortgage,  but  with  different  rates  of  interest,  different 
maturities  and  certain  other  differences. 


FINANCING  141 

the  principle  of  wholesale  financing  is  applied  in  raising 
funds  for  the  subsidiary.  To  have  the  subsidiary  issue 
its  own  bonds  would  involve  two  disadvantages.  In 
the  first  place,  the  issue  would  be  small,  would  have  a 
narrow  market,  would  not  be  well  known,  and  therefore 
would  require  for  flotation  a  high  rate  of  interest.  More- 
over, the  issue  of  bonds  would  jeopardize  the  parent  com- 
pany's interest  in  the  subsidiary,  since  the  bonds  would 
have  claims  better  than  that  of  the  stock  with  which  the 
parent  controls  the  subsidiary.  To  avoid  these  difficul- 
ties, the  parent  company  usually  issues  some  of  its  bonds 
under  its  large  refunding  mortgage  and  advances  the 
proceeds  to  the  subsidiary,  taking  the  latter's  notes  and 
pledging  them  as  extra  security  for  the  refunding  bonds. 

In  some  cases,  however,  it  is  better  to  have  the  sub- 
sidiary sell  its  own  bonds.  Thus,  if  the  subsidiary  com- 
pany's credit  were  much  stronger  than  that  of  the  parent 
company,  it  could  probably  borrow,  even  on  a  small,  issue 
of  bonds,  on  better  terms  than  could  the  parent  company. 
And  if  the  parent  company  were  simply  to  guarantee  to 
pay  the  bonds  of  the  subsidiary,  in  case  of  the  latter's 
default,  still  lower  interest-rates  could  be  obtained.  The 
advantage  to  the  parent  company  would  be  that  the  sub- 
sidiary company,  not  having  to  pay  as  much  interest, 
would  have  a  larger  surplus  to  distribute  in  the  form  of 
dividends  to  its  stockholder,  the  parent  company. 

Regulating  the  income  on  bonds. — ^Usually,  when 
bonds  are  issued  by  a  corporation,  they  bear  a  fixed  rate 
of  interest — as  4  per  cent,  5  per  cent,  or  6  per  cent. 
This  feature  of  the  bond  appeals  to  the  conservative  in- 
vestor, who  likes  to  have  a  certain  fixed  income  every 


142  PRINCIPLES  OF  BUSINESS 

year.  But  sometimes  the  corporation  feels  (usually  after 
a  reorganization)  that  it  does  not  want  to  take  the  risk 
of  being  compelled  to  pay  the  fixed  amount  each  year. 
The  corporation  may  not  be  quite  certain  that  it  will  be 
able  to  earn  or  pay  the  full  amount  of  interest,  and  if  it 
does  not,  the  holders  of  ordinary  bonds  can  sue  the  cor- 
poration. So  the  corporation  will  ask  the  investors  to 
share  the  risk  of  earnings  by  accepting  income  bonds. 
The  holders  of  these  bonds  receive  only  so  much  of  the 
stipulated  rate  of  interest  as  is  earned.  The  corporation 
need  not  fear  that  it  will  be  unable  to  meet  its  interest 
requirements,  for  it  need  pay  only  what  it  earns  and  no 
more.  While  this  is  an  ideal  form  of  obligation  for  a 
corporation  to  incur,  there  are  few  investors  who  would 
be  attracted  to  such  securities.  Indeed,  we  find  income 
bonds  issued  almost  exclusively  by  reorganized  companies 
to  security  holders  of  the  former  insolvent  company,  who 
have  little  choice  in  the  matter.  On  the  other  hand  there 
are  some  companies  so  anxious  to  sell  their  bonds  that 
they  not  only  agree  to  pay  the  bondholder  a  fixed  annual 
interest  but  a  share  of  the  profits  in  addition — by  issuing 
so-called  profit-sharing  or  participating  bonds.  Such 
bonds,  however,  are  usually  issued  only  by  companies 
whose  credit  is  not  strong  enough  to  interest  conserva- 
tive investors  in  debenture  bonds  and  who  have  not  suffi- 
cient property  to  support  a  mortgage-bond  issue.  Such 
companies,  therefore,  appeal  to  the  speculative  investor 
by  offering  profit-sharing  bonds. 

The  amount  of  bonds  that  can  be  sold. — Large  con- 
cerns, at  any  rate,  are  not  nearly  so  much  interested  in 
the  relation  of  the  amount  of  bonded  indebtedness  to  the 


FINANCING  143 

value  of  the  assets  securing  it  as  they  are  in  the  relation 
of  the  fixed  charges  (i.e.,  the  interest)  growing  out  of 
the  indebtedness  to  the  net  income  available  for  the  pay- 
ment of  these  fixed  charges.  It  can  be  shown  mathe- 
matically that  the  more  stable  the  gross  income  of  a 
company,  the  greater  can  be  its  financial  risk.^  Rail- 
roads and  public  utilities  generally  can  stand  larger  bond 
issues  than  industrials.  The  industrials  can  stand  large 
issues  in  proportion,  as  we  have  seen,  to  the  stability  of 
their  gross  income.  This  stability  may  be  increased  by 
good  management,  and  will  depend  on  whether  the  com- 
pany is  manufacturing  a  basic  necessary  or  a  luxury,  and 
on  whether  it  enjoys  a  complete  or  partial  monopoly. 

1  Financial  risk  is'  the  ratio  of  financial  fixed  charges  (to  be 
differentiated  from  other  fixed  charges  such  as  taxes)  to  the  net 
income.  The  mathematical  demonstration,  which  the  author  has 
used  for  a  number  of  years  in  class  demonstration,  but  which  as  far 
as  he  knows  has  never  been  published  before,  is  as  follows : 

Let  a  =  gross  income  in  normal  year. 

b  =  decrease  of  gross  income  in  the  poorest  year, 
m  =  operating  ratio   (ratio  of  operating  expenses  to  gross). 
x  =  financial  risk,  i.e.,  the  largest  possible  risk  that  can  be  met  in 
any  (i.e.,  the  poorest)  year. 

Normal  year                                Poorest  year 
Gross  income                         a                                         a  —  b 
Operating  exp.  am  (a  —  b)  m 

Net   income  a  —  am  (a  —  b)  —  (a  —  b)  m 

Fixed  ch'ges  x  (a  —  am) 

The  quantity  x  (a  —  am)  is  unknown,  since  one  term  is  unknown. 
Whatever  it  amounts  to,  it  is  by  its  very  nature  constant,  i.e.,  it  will 
not  vary  from  year  to  year.  It  should  not  be  larger  than  the  net 
income  in  the  poore>t  year,  but  it  may  be  as  large ;  in  other  words, 
it  may  be  equal.  Thus  x  (  a  —  am)  =  (a  —  b)  —  (a  ~  b)  m.  Fac- 
toring and  solving  for  x : 

(a  —  b)  (i  —  m)         a  —  b 

x=    7 ^ =   

a  (i  —  m)  a 

That  is,  the  financial  risk  (x)  may  be  equal  to  the  ratio  of  the 
gross  income  in  the  poorest  year  (a  —  b)  to  the  gross  income  in 
the  normal  year   (a). 


144  PRINCIPLES  OF  BUSINESS 

When  to  sell  securities. — We  have  discussed  the 
question  of  whether  bonds,  or  stock,  shall  be  sold.  We 
may  now  pause  for  a  moment  to  consider  conditions  out- 
side the  business  that  will  have  some  effect  on  the  ability 
oi  a  company  to  market  its  securities.  In  brief,  the  time 
to  sell  securities  is  when  money  is  "easy" — when  it  is 
plentiful.  There  are  two  cycles  of  business  conditions 
that  must  be  considered — the  absolute  and  the  annual. 
Absolutely,  we  find  periods  of  prosperity  when  money  is 
plentiful  and  when  all  businesses  borrow  in  order  to  get 
the  advantage  of  easy  rates  and  also  to  get  advantage 
of  the  general  prosperity.  Credit  soon  becomes  dis- 
tended, and,  in  the  days  before  the  Federal  Reserve  Sys- 
tem was  in  existence  and  able  with  its  system  of  redis- 
counting^  to  make  the  currency  elastic,  frequently  broke 
under  the  strain.  We  then  had  a  panic,  followed  by  a 
period  of  depression  during  which  securities  of  all  kinds 
were  difficult  to  sell. 

In  the  annual  cycle,  we  find  early  in  the  calendar  year 
a  relative  plenitude  of  funds  made  available,  through 
the  end-of-the-year  distribution  of  business  profits,  the 
laying-up  of  funds  by  farmers,  and  the  lull  in  business 
following  the  hohday  season.  This  is  ordinarily  the 
time  of  the  year  when  most  security  issues  are  launched. 
Then  comes  the  seed  period  and  spring  revival,  followed 
by  another  lull,  after  which  comes  the  great  fall  demand 
for  funds  to  move  the  crops.  Then  as  the  lakes  freeze 
up,  and  as  business  gradually  slows  up,  following  the 
cessation  of  productive  farm  work,  funds  begin  to  pile 
up  again  till  the  next  profit-dividing  day — January  i. 

1  See  Giapter  on  Banking. 


FINANCING  145 

LONG-TERM   AND  SHORT-TERM   BONDS 

Nine  hundred  and  ninety-nine  year  bonds. — ^It  "vvas 
quite  natural  twenty  or  more  years  ago,  when  corpora- 
tions could  get  their  capital  at  3^  and  4  per  cent,  for 
them  to  make  contracts  for  ninety-nine  years  or  even, 
for  nine  hundred  and  ninety-nine  years. 

When  capital  grew  more  expensive,  corporations  were 
unwilling  to  commit  themselves  to  long-term  contracts  at 
high  rates.  Let  us  suppose,  as  was  frequently  the  case, 
that  some  kind  of  a  contract  must  be  made,  either  be- 
cause an  old  bond  issue  has  matured  and  must  be  re- 
newed or  because  the  corporation  has  begun  some  form 
of  expansion  or  improvement  and  must  see  it  through, 
unless  it  is  willing  to  sacrifice  large  sums  of  capital  al- 
ready invested.  A  railroad,  for  example,  may  have  in- 
vested millions  in  a  new  branch,  and,  until  more  millions 
are  spent,  the  road  will  not  be  fit  for  operation.  If  it 
holds  up  construction,  the  work  thus  far  done  will  yield 
no  income,  though  interest  charges  and  depreciation  will 
continue  to  demand  attention. 

Redeemable  bonds. — When  a  company  finds  itself  in 
such  a  predicament  it  may  do  one  of  two  things :  sell 
high  )nelding  bonds  with  the  redemption  feature,  or  sell 
short-term  notes.  Which  of  these  courses  will  be  pur- 
sued will  depend  largely  on  circumstances  and  on  the 
directors'  estimate  of  the  probable  duration  of  the 
period  of  high  interest-rates.  If  interest  rates  are  likely 
to  be  high  for  a  number  of  years,  say  more  than  five, 
the  company  will  probably  sell  six  per  cent  bonds,  with 
a  clause  permitting  it,  whenever  it  chooses,  to  hand  the 


146  PRINCIPLES  OF  BUSINESS 

bondholders  back  their  money,  plus  a  premium.  When 
interest  rates  drop,  the  company  will  sell  a  new  issue 
with  a  lower  rate  and  out  of  the  proceeds  of  these  new 
bonds  it  will  redeem  the  older  high-rate  bonds.  While 
this  operation  may  appear  to  be  expensive,  it  is  much 
cheaper  in  the  long  run  than  paying  six  per  cent  interest 
for  a  number  of  years  in  the  future. 

The  profitableness  of  redemption  can  be  seen  from 
working  out  a  concrete  example.  A  company,  let  us  say, 
has  a  $1,000,000  issue  of  six  per  cent  bonds  that  have 
seventy-five  years  to  run.  It  can  redeem  these  bonds, 
but  the  mortgage  provides  that  the  price  at  which  they 
may  be  redeemed  is  no.  This  means  that  the  com- 
pany will  have  to  pay  $1,100  for  every  $1,000  originally 
paid  by  the  bondholder.  Interest  rates,  however,  are 
lower,  so  that  now  the  company  can  sell  bonds  bearing 
interest  at  5  per  cent.  So  it  issues  $1,100,000  of  5  per 
cent  bonds  due  in  75  years  and  with  the  proceeds  of 
the  sale  redeems  the  6  per  cent  bonds.  The  annual  in- 
terest now  is  $55,000,  as  compared  with  $60,000  formerly 
paid.  This  is  a  saving  of  $5,000  a  year,  or  $375,000  in 
75  years,  disregarding  interest  on  the  interest  saved. 
This  offsets  the  $100,000  premium  paid  to  redeem  the 
old  bonds,  and  saves  the  company  enough  to  pay  a  large 
part  of  the  original  debt. 

Short-term  notes. — But  instead  of  issuing  redeem- 
able bonds,  the  company  may  decide  to  issue  short-term 
notes,  which  may  at  their  maturity  be  paid  off  with  the 
proceeds  of  a  bond  issue,  if  interest  rates  are  lower,  or 
with  the  proceeds  of  a  new  note  issue  if  interest  rates 
are  still  high.     Now  a  short-term  note  is  practically  a 


FINANCING  147 

bond.  In  fact,  there  are  some  securities  that  are  called 
bonds  that  are  really  short-term  notes,  and  there  are 
some  notes  that  are  more  like  bonds.  It's  all  in  the  name. 
Out  West,  for  example,  they  call  the  paper  that  is  given 
to  evidence  the  debt  secured  by  an  ordinary  real-estate 
mortgage  a  note.  Farmer  Jones  gives  his  notes  and 
mortgage,  for  example,  to  secure  the  $5,000  he  borrows 
from  the  bank.  In  the  East,  the  term  used  is  generally 
"a  bond  and  mortgage."  But  the  note  and  the  bond, 
West  and  East,  are  just  alike. 

Down  in  Wall  Street,  when  you  speak  of  a  note,  the 
broker  or  other  man  of  financial  affairs  will  immediately 
picture  to  himself  a  debt-evidencing  instrument  that  will 
come  due  in  less  than  ten  years;  and  when  you  speak  of 
a  bond,  he  pictures  to  himself  a  debt-evidencing  instru- 
ment that  will  come  due  in  ten  years  or  more  after  it 
is  issued.  That  is  the  only  practical  difference  between 
the  bond  and  the  note.  And  still,  some  companies  call 
their  ten-year  debts  "notes" ;  and  others  call  their  five- 
year  debts  "bonds." 

Just  as  there  are  many  kinds  of  bonds,  so  are  there 
many  kinds  of  notes.  We  can  have  mortgage  and  deben- 
ture, income  and  participating  and  all  the  other  "fifty- 
seven  varieties"  of  notes.  But  because  the  note  is  ;iot 
going  to  be  outstanding  very  long,  corporations  usually 
make  them  plain,  straight  interest-bearing  secured  or  un- 
secured obligations.  If  a  company  is  in  very  good  stand- 
ing, it  may  issue  simple  debenture  notes.  These  notes 
then  are  just  like  an  ordinary  promissory  note,  though, 
indeed,  they  will  contain  a  great  many  more  words,  most 
of  which  will  be  used  to  tell  what  will  happen  if  the 


148  PRINCIPLES  OF  BUSINESS 

company  fails  to  pay  the  interest  on  the  notes  or  the 
principal  when  it  falls  due.  An  example  of  these  de- 
benture notes  is  the  small  issue  recently  brought  out  in 
Cleveland  of  the  Champion  Hardware  Company.  These 
notes  contain  a  clause  that  it  is  wise  to  look  for  in  all 
debenture  notes — a  clause  providing  that  no  mortgages 
may  be  placed  on  the  company's  property  while  any  of 
the  notes  are  outstanding. 

More  commonly,  however,  the  short-term  note  will  be 
a  collateral  trust  note;  it  will  be  secured  either  by  a  lot 
of  free  stocks  and  bonds  owned  by  the  company — that 
is,  stocks  and  bonds  of  subsidiary  companies  that  have 
not  been  pledged  under  some  mortgage — or  it  will  be 
secured  by  a  lot  of  bonds  bearing  a  lower  rate  of  in- 
terest than  the  notes,  which  bonds  the  company  hopes  to 
be  able  to  sell  when  the  money  market  is  easier — when 
interest  rates  are  lower. 

EXTINCTION   AND   REFUNDING   OF  INDEBTEDNESS 

Extinction  of  indebtedness. — When  a  company  is- 
sues short-term  notes  it  should  never  lose  sight  of  the 
maturity  of  those  notes.  Some  provision  must  be  made 
to  pay  off  the  noteholders,  or  they  may  force  the  com- 
pany into  a  receivership.  If  the  notes  are  issued  for 
temporary  purposes,  as  to  provide  the  company  with 
sufficient  working  capital  to  finance  the  purchase  of  an 
unusually  large  amount  of  materials  required  for  the 
completion  of  a  large  special  contract,  the  money  to  pay 
off  the  notes  should  come  from  the  payments  received 
on  the  contract.  This  was  the  practice  followed  by  a 
number  of  companies  that  required  additional  working- 


FINANCING  149 

capital  for  the  manufacture  of  large  quantities  of  muni- 
tions in  the  Great  War.  On  the  other  hand,  if  the  money 
originally  was  borrowed  to  finance  some  permanent  ad- 
ditions, and  short-term  notes  were  issued  simply  because 
interest  rates  were  too  high  to  warrant  a  bond  issue, 
there  is  no  good  reason,  except  perhaps  ultra-conserva- 
tism, why  the  debt  should  be  entirely  extinguished.  The 
fact  that  it  was  profitable  for  the  company  to  borrow  in 
the  first  place  would  ordinarily  be  sufficient  reason  for 
continuing  the  debt.  Under  these  circumstances,  then, 
the  company  will  pay  off  the  debt,  or  a  portion  of  the 
debt,  only  if  it  has  on  hand  funds  that  it  cannot  profitably 
use  in  the  business,  and  the  remainder  of  the  debt  will, 
if  possible,  be  continued.  If  interest  rates  are  still  high, 
new  notes  will  be  issued  for  another  short  period,  or  the 
old  noteholders  will  be  asked  to  extend  the  notes.  If 
they  do,  the  company  will  save  a  large  part  of  the  trouble 
and  expense  of  selling  new  notes. 

Bonds,  too,  must  be  taken  care  of  at  maturity.  In 
some  cases,  where  the  earnings  of  the  company  are  stable, 
and  where  the  plant  is  not  subject  to  accident  or  serious 
danger  or  neglect,  as  in  the  case  of  a  railway  or  gas 
company,  the  bonds  are  entirely  refunded  and  the  debt 
remains  practically  undisturbed.  That  is  to  say.  new 
bonds  are  either  exchanged  for  the  old  bonds.  Or  new 
bonds  are  sold  and  the  proceeds  used  to  take  up  the 
old  bonds.  A  company  is  justified  in  doing  this  provid- 
ing ( I )  the  security  back  of  the  bonds  is  unimpaired ; 
(2)  it  is  still  more  profitable  for  the  company,  from  the 
stockholders'  standpoint,  to  borrow  than  to  sell  addi- 
tional stock,  and  (3)  the  company  has  on  hand  no  ex- 


I50  PRINCIPLES  OF  BUSINESS 

cess    of    funds    that    it    cannot    use    profitably    in    the 
business. 

The  bondholders'  interests  must  also  be  considered. 
And  indeed,  the  bondholders  will  usually  insist  that  the 
debt  be  reduced  gradually  during  the  life  of  the  bond 
issue.  This  is  particularly  true  when  the  borrower  is  an 
industrial  company  and  where  there  is  danger  of  shrink- 
age in  value  of  the  property  through  accident  or  im- 
proper maintenance.  And  in  the  case  of  extractive  busi- 
nesses, such  as  coal  mines  or  lumber,  the  bondholders 
usually  require  the  company  to  wipe  out  the  debt  entirely 
wdthin  the  life  of  the  bond  issue  and  proportionately  at 
least  as  rapidly  as  the  coal  is  mined  or  the  lumber  cut. 

Sinking  funds  and  serial  bonds. — In  the  above  cases, 
the  mortgage,  which  defines  the  bondholders'  rights, 
would  require  the  company  to  reduce  the  debt  gradually. 
This  may  be  done  in  one  of  two  ways :  ( i )  by  making 
a  certain  part  of  the  bonds  mature  each  year  during  the 
life  of  the  issue  (in  which  case  the  bonds  would  be  called 
serial  bonds),  or  (2)  by  requiring  the  company  to  lay 
aside,  usually  from  profits,  a  fund  sufificient  to  redeem  a 
portion  of  the  bonds  each  year.  This  sum  may  be  a 
fixed  amount  or  may  be  in  proportion  to  the  earnings  of 
the  company  or  in  proportion  to  the  amount  of  property 
used,  as  so  much  per  ton  of  coal  mined.  The  funds  will 
then  either  be  used  immediately  to  redeem  a  portion  of 
the  outstanding  bonds  or  they  will  be  accumulated  and 
invested  in  banks  or  other  securities  and  used  to  pay  ofif 
all  the  bonds  at  maturity.  The  former  method  is  more 
economical  and  much  safer,  particularly  for  the  bond- 
holders. 


FINANCING  151 

Conversion  of  bonds. — Another  method  of  extin- 
guishing a  debt  is  to  exchange  it  for  an  ownership- 
interest  in  the  company.  Of  course,  this  cannot  be  done 
without  the  consent  of  the  bondholders  or  noteholders. 
Nor  do  the  owners  of  a  profitable  enterprise  like  to  do 
this  if  they  can  extinguish  the  debt  in  any  other  way. 
A  company,  however,  that  cannot  offer  the  bondholder 
sufficient  safety  must  compensate  him  in  some  other  way. 
This  may  be  done,  as  previously  indicated,  by  making 
the  bonds  participating  or  profit-sharing.  Or  the  com- 
pany may  make  the  bonds  convertible;  that  is  to  say,  it 
may  give  the  bondholder  the  right  to  exchange  his  bonds 
for  the  stock  of  the  company  at  a  fixed  rate  of  exchange. 
If  the  company's  earnings  afterwards  increase  consid- 
erably, the  stock  will  become  more  valuable  and  the  bond- 
holder will  profit  by  converting  his  bonds.  This  operates 
greatly  to  the  advantage  of  the  bondholder,  and  to  the 
disadvantage  of  the  corporation  and  its  original  stock- 
holders; for  if  the  corporation's  business  grows  success- 
fully, the  convertible-bond-holders  can  share  in  the  profits, 
by  converting  their  bonds,  without  taking  any  of  the 
initial  risk — and  if  the  company  is  unsuccessful,  the 
holder  of  convertible  bonds  will  keep  his  bonds  and  en- 
force his  rights  just  as  would  any  other  bondholder  or 
creditor.  As  a  general  rule,  then,  a  corporation  should 
not  issue  convertible  bonds  unless  it  is  compelled  to  do  so 
in  order  to  make  its  bonds  sufficiently  attractive  to  invite 
the  attention  of  investors. 

SELLING  SECURITIES 

Methods  of  selling  securities. — The  corporation  has 
several  methods  by  which  it  may  sell  securities  to  provide 


152  PRINCIPLES  OF  BUSINESS 

itself  with  initial  capital,  or  later  with  capital  for  ex- 
pansion. Of  course,  as  we  have  already  indicated,  a  large 
part,  or  all,  of  the  capital  necessary  for  expansion  may 
come  from  profits  not  distributed  to  shareholders.  If  an 
established  corporation  sells  new  stock,  it  must  remember 
that  stock  is  the  basis  of  control  as  well  as  of  income. 
A  legal  rule  has  sprung  up  to  the  effect  that  when  new 
issues  of  stock  are  offered,  they  must  be  tendered  first  to 
the  old  stockholders  in  proportion  to  their  old  holdings. 
But,  aside  from  this  rule,  it  is  generally  advantageous  to 
go  to  the  old  stockholders  first.  They  know,  the  enter- 
prise and  they  have  something  at  stake  that  makes  them 
anxious  to  see  the  new  offering  go  through  successfully. 
Likewise,  although  in  the  case  of  bonds,  there  is  no  such 
obligation  involved,  bonds  are  frequently  offered  to  the 
stockholders  before  a  general  public  offering  is  made. 

There  is  also  a  growing  tendency  among  corporations 
to  offer  stock  to  employees  and  others  connected  with 
the  enterprise.  Thus  we  find  such  corporations  as 
United  States  Steel  offering  shares  to  employees  at  prices 
less  than  the  market.  It  does  this  largely  because  em- 
ployees who  have'  a  proprietary  interest  in  the  business 
are  likely  to  try  to  increase  the  profits  by  working  more 
diligently.  Acting  on  a  somewhat  similar  theory,  some 
corporations  attempt  to  sell  as  much  of  their  stock  as 
possible  to  customers.  Two  wholesale  and  manufactur- 
ing drug  companies  successfully  sold  their  stock  to  retail 
druggists  and  in  so  doing  created  a  potential  market  for 
all  their  products.  The  Pacific  Gas  and  Electric  Com- 
pany and  many  other  public  utilities  have  sold  shares 
to  consumers  of  gas  and  electricity  and  thus  have  won 


FINANCING  153 

their  co-operation,  as  well  as  the  good-will  of  the  gov- 
ernmental authorities,  particularly  needed  on  those  occa- 
sions when  rates  are  unduly  lowered  or  heavy  restrictions 
placed  upon  the  public  utility. 

In  making  a  general  public  offering,  however,  it  is 
unusual,  as  well  as  unwise,  for  a  company  to  go  direct 
to  prospective  purchasers.  A  banking  concern  should 
be  used.  It  will  know  where  to  find  the  buyers  and  it 
will  render  aid  in  advising  the  kind  of  security  to  offer 
and  the  time  and  conditions  under  which  the  offer  should 
be  made. 

Underwriting  syndicates. — When  a  company  needs 
money,  and  is  entitled  to  it  from  its  economic  position,  it 
may  assure  to  itself  the  sale  of  its  securities  by  having 
the  sale  underwritten.  Usually,  in  modern  days,  a  bank- 
ing house  will  actually  buy  the  securities  first,  and  then 
form  and  manage  a  syndicate  of  banking  houses  to  as- 
sure their  sale  to  the  public.  The  participants  (members 
of  the  syndicate)  leave  the  entire  management  of  the 
syndicate  to  the  manager,  and  will  be  satisfied  to  get 
their  final  statement  of  profits. 

Since  the  time  during  which  the  securities  are  sold, 
as  well  as  their  ultimate  sale,  is  usually  important,  the 
syndicate  agreement  will  ordinarily  provide  that  the  man- 
ager may  make  "calls"  on  the  participants  in  proportion 
to  tlieir  shares.  Thus  if  the  syndicate  has  agreed  to  sell 
the  entire  lot  in  a  year  in  equal  monthly  instalments,  it 
may  be  impossible  to  sell  any  during  the  first  month ;  the 
manager  will  then  call  on  the  participants  to  advance  an 
amount  equal  to  one-twelfth  the  amount  of  their  subscrip- 
tions.    At  the  end  of  the  year,  if  all  the  securities  are 


154  PRINCIPLES  OF  BUSINESS 

sold,  the  participants  will  get  their  money  back  and  a 
share  of  the  profits  proportionate  to  their  subscriptions. 
If  some  of  the  securities  remain  unsold,  the  participants 
will  take  them  at  the  syndicate  price/ 

The  expenses  of  the  syndicate  include  the  costs  of  the 
various  forms  of  advertisements  and  the  other  expenses 
of  the  manager.  These  latter  may  include  fairly  large 
sums  for  "supporting  the  market." 

The  right  and  duty  to  support  the  market  are  provided 
for  in  the  syndicate  agreement.  Thus,  if  the  securities 
are  sold  on  any  of  the  exchanges,  and  they  fall  in  price 
below  the  price  at  which  they  are  to  be  sold  to  tlie  public, 
the  manager  may  order  brokers  to  buy  the  securities  to 
raise  the  price."  The  brokers'  commissions,  of  course, 
are  a  legitimate  expense  of  the  syndicate. 

Stock  exchange  as  an  aid. — The  manipulative  use  of 
the  stock  exchanges  indicated  in  the  previous  section  is 
undoubtedly  a  social  detriment.  Markets  have  been 
"supported"  at  levels  which  the  intrinsic  values  of  the 
securities  do  not  warrant  ^  But  the  stock  exchanges  do 
perform  a  great  service  in  establishing  prices  that  can 
be  used  as  the  basis  of  sales  and  hypothecations.* 

Prospectuses. — Securities   ordinarily  are  brought  to 

1  The  "syndicate  price"  is  the  price  at  which  the  manager  turns 
the  se«urities  over  to  the  syndicate,  and  is  usually  a  fraction  of  a 
point  more  than  the  corporation  receives  for  its  securities.  The 
syndicate  gross  profits  are  the  difference  between  the  syndicate 
price  and  the  price  at  which  the  securities  are  sold  to  the  public. 

-  See  Gerstenberg's  Materials  of  Corporation  Finance,  pp.  405 
and  769. 

^  See  the  Pujo  Committee's  Report  on  the  California  Oil  Com- 
pany and  the  subsequent  course  of  that  company's  stock.  (Gersten- 
berg's'  Materials  of  Corporation  Finance,  p.  435.) 

4  See  Emery's  Speculation  on  the  Stock  and  Produce  Exchanges 
and  Brace's  The  Value  of  Organised  Speculation. 


FINANCING  155 

the  attention  of  prospective  buyers  through  prospectuses 
or  bond  circulars.^  In  England  and  Canada,  when  a 
DubHc  offering  is  made  the  prospectus  must  be  filed  in 
public  offices  and  the  information  it  must  contain  is  pre- 
scribed by  law. 

A  prospectus  should  contain  a  complete  statement  of  all 
the  obtainable  facts  necessary  to  aid  the  prospective  pur- 
chaser in  estimating  the  worth  of  the  securities.  The 
nature  of  the  business,  the  past  earnings,  the  careers  of 
the  managers,  the  nature  of  the  company's  property  are 
essential  facts.  If  the  prospectus  goes  beyond  this  and 
deals  with  the  profits  of  like  concerns,  different  in  every- 
thing but  the  general  nature  of  the  product,  or  if  the 
cheap  persuasion  of  the  fire-sale  clothing  merchant  is 
indulged  in,  the  concern  immediately  loses  caste  and  be- 
comes the  child  of  a  "wild-catter."  Respectable  bankers 
let  the  facts  speak  for  themselves.  Perhaps  no  other 
selling  device  is  so  reprehensible  as  the  prediction  of  what 
will  happen.  There  used  to  be  a  very  wide  margin  drawn 
by  the  law  between  statements  of  facts  and  statements  of 
opinion.  A  false  statement  of  facts  could  be  used  as  the 
basis  of  criminal  prosecution  for  false  representations; 
statements  of  opinions  were  privileged — the  law  being 
that  every  person  is  entitled  to  his  own  opinion.  But 
the  courts  are  beginning  to  draw  a  closer  line,  and  a 
statement  of  opinion  that  is  calculated  to  get  a  person's 
money,  but  that  is  not  honestly  made,  may  be  made  the 
basis  of  a  suit — at  least  under  the  decisions  of  the  United 
States  Supreme  Court. 

^In  practice  a  prospectus  deals  with  a  new  company,  while  a 
bond  or  stock  circular  advertises  the  issues  of  new  securities  of  an 
established  company. 


156  PRINCIPLES  OF  BUSINESS 

"Catch  phrase"  financial  advertising. — It  is  esti- 
mated that  about  $100,000,000  a  year  is  lost  in  the  United 
States  through  "investments"  in  fraudulent  stock-jobbing 
schemes.  This  $100,000,000  does  not  go  into  the  pockets 
of  stock-jobbers  to  be  lavished  on  lobster  and  champagne 
parties  as  is  popularly  supposed.  The  waste  is  greater 
than  this.  A  large  part  of  the  $100,000,000  goes  into 
stenographer's  services,  mail  service,  newspaper  and  other 
printing,  all  of  which  expense  is  an  economic  loss.  How 
much  better  to  have  this  $100,000,000  in  legitimate  en- 
terprises ! 

It  was  formerly  held,  in  some  quarters — and  the  mis- 
apprehension persists  even  today — that  the  legitimate 
jobber  in  stocks  and  bonds  must  use  none  of  the  devices 
open  to  the  vendors  of  general  merchandise.  The  result 
has  been  that  the  "fake''  brokers  have  had  a  monopoly 
of  the  advertising  in  the  financial  field.  Gradually,  how- 
ever, even  the  better-grade  houses  have  been  getting  away 
from  the  old,  conservative  and  often  profitless  advertis- 
ing that  consists  merely  of  inserting  a  professional  card. 
Such  bait  never  caught  a  fish ;  investors  are  hooked  by 
the  "catch  phrases" — such  as  "A  competency  for  old 
age,"  "Let  your  dollars  help  your  brains,"  "Diversify 
your  investments,"  and  the  like — that  are  being  wisely 
used  by  the  progressive  houses. 

"Blue  sky"  legislation. — So  much  money  year  after 
year  has  l)een  wasted  in  the  purchase  of  worthless  secur- 
ities that  in  191 1  Kansas  passed  a  so-called  "blue  sky" 
law  for  the  protection  of  its  investing  public.  As  the 
name  of  this  law  indicates,  it  was  intended  to  keep  stock 
salesmen  from  selling  pieces  of  "blue  sky,"  blue  sky  bein^ 


FINANCING  157 

for  many  years  the  figurative  designation  of  a  worthless 
security.  Many  States  since  then  have  passed  similar 
laws,  and  these  have  been  held  constitutional  by  the 
United  States  Supreme  Court.  Generally,  the  laws  pro- 
vide that  securities  can  be  sold  by  licensed  vendors  only, 
and  that  the  securities  themselves  must  be  passed  on  by 
a  licensing  board. 

Money-raising  and  money-making. — This  perhaps 
is  the  place  to  say  a  word  about  the  difference  between 
money-making  and  money-raising. 

Money-making  is  usually  the  result  of  either  painfully 
assiduous  and  intelligent  effort  or  of  what  seems  to  be 
fortuitous  luck.  Of  the  former,  little  need  be  said  be- 
yond calling  attention  to  the  fact  that  practically  all  our 
industrial  plants  of  huge  success  are  oaks  that  have 
grown  from  small  acorns.  As  to  the  latter,  it  is  well 
to  point  out  that  the  "fortuitous  luck"  seems  to  be  a 
matter  of  habit  with  some  people.  Perhaps  there  is 
neither  luck  nor  fortuitousness  in  the  good  fortune  of  the 
"idle  rich."  The  fact  is,  that  some  people  intuitively  sense 
the  strategy  of  industrial  evolution.  They  make  contracts 
that  involve  the  large  demands  of  the  moment — war  con- 
tracts, railroad  contracts,  shipping  contracts,  and  the 
like. 

There  is  another  entirely  different  activity,  to  be  dif- 
ferentiated from  laborious  production  and  selling  and 
from  big-scale  trading  such  as  is  involved  in  selling  "con- 
trolling interests"  and  the  like.  This  activity  is  money- 
raising.  Some  men  have  the  happy  faculty  of  inspiring 
confidence  and  of  being  able  to  raise  money  for  this  or 
that  enterprise.     In  the  long  run,  it  will  be  found  that 


158  PRINCIPLES  OF  BUSINESS 

these  men  give  effort  to  money-raising  that  is  not  out 
of  proportion  to  the  success  they  attain.  This  effort,  to 
be  sure,  may  seem  to  be  the  pleasurable  occupation  of 
being  a  club  member,  being  a  "social  climber,"  or  the 
like.  At  any  rate  the  successful  money-raiser  is  likely 
to  have  personal  qualities  that  make  him  attractive  to 
his  fellow  human-beings  in  a  way  that  is  to  be  envied. 

Raising  money,  of  course,  is  not  the  whole  of  the 
matter.  If  one  who  raises  money  easily  does  not  know 
how  to  use  it,  the  faith  people  have  in  him  will  soon  be 
lost.  If  to  his  money-raising  ability,  he  adds  the  ability 
to  choose  associates  who  can  make  good  use  of  his  money, 
his  success  will  continue.  This  two-fold  ability  to  raise 
money  and  to  use  it  properly  is  the  very  basis  of  the  suc- 
cess of  the  so-called  "Wall  Street  Man." 


CHAPTER    VIII 

FINANCING 

(Continued) 

MANAGEMENT   OF    INCOME 

Control  o£  income. — Gross  income  depends  upon  the 
ttumber  of  units  sold  and  the  price  per  unit.  Both  these 
elements  are  matters  for  the  marketing  expert  rather  than 
for  the  financial  expert. 

The  financial  success  of  an  enterprise,  however,  de- 
pends to  a  considerable  extent  upon  the  gross  income. 
It  must  be  large  enough  not  only  to  pay  the  operating  ex- 
penses of  the  business,  to  pay  a  fair  return  on  the  capital 
invested  and  to  provide  a  fair  margin  to  compensate  the 
projectors  of  the  enterprise,  but  also  properly  to  maintain 
the  plant  and  to  insure  the  future  success  of  the  business. 
In  the  case  of  an  enterprise  with  wasting  assets,  as  a 
coal  mine,  the  gross  income  must  also  provide  a  surplus 
sufficient  to  return  to  the  owners  the  capital  invested. 

The  first  demand  on  income  is  for  operating  expenses. 
The  most  important  problem  to  be  considered  under  this 
head  is  the  question  of  proper  maintenance  of  the  plant 
and  the  introduction  of  betterments  that  may  reduce  oper- 
ating costs. 

Maintenance. — Maintenance  is  to  be  classified  into 
"present"  and  ^'deferred."  Present  maintenance  is  pro- 
vided for  in  the  actual  expenditures  for  current  repairs 

159 


i6o  PRINCIPLES  OF  BUSINESS 

and  replacements.  Deferred  maintenance  is  cared  for 
by  deducting  from  the  income  an  amount  for  depreciation 
to  take  care  of  gradual  wearing  and  tearing  of  property 
that  cannot  economically  be  repaired  or  replaced  within 
the  financial  period.  The  amounts  so  deducted  are  placed 
in  reserve  accounts.  This  prevents  the  directors  from 
regarding  that  part  of  the  income  as  available  for  dis- 
tribution as  dividends  and  compels  them  to  keep  it  in 
the  concerns  to  enable  the  repairs  to  be  made  in  future 
financial  periods  when  they  should  be  made,  without, 
however,  appearing  to  be  a  heavy  financial  burden  during 
the  year  in  which  they  are  made. 

Whether  or  not  betterments  should  be  made  is  a  simple 
question  of  economic  selection.  If  a  machine,  for  ex- 
ample, can  reduce  operating  expenses  by  dispensing  with 
the  labor,  say,  of  five  men,  the  machine  ought  to  be  in- 
stalled, if  the  interest  on  the  capital  cost  plus  the  costs 
of  maintaining  the  machine  are  less  than  the  wages  of 
the  five  men.  Money  spent  on  other  terms  for  a  capital 
asset  is  not  economically  invested. 

Taxation. — Before  the  day  of  public  regulation,  public 
expenses — except  in  war  time — were  small,  and  taxes 
fairly  light.  But  the  nation  and  the  States  and  even  the 
cities  have  extended  their  scope  of  operations,  have  re- 
quired more  money,  and  have  therefore  required  business 
men  to  take  taxes  into  consideration  when  making  finan- 
cial plans.  Of  course,  the  debt  of  the  Great  War  will  be 
with  us  for  a  long  time  and  taxes,  therefore,  are  likely  to 
be  heavy  for  some  time  in  the  future.  Every  business  man 
should  understand  his  financial  obligations  to  the  Govern- 
ment.    This  is  not  the  place  to  explain  these  obligations 


FINANCING  i6i 

at  length.  The  State  taxes,  license  fees,  and  other  bur- 
dens must  be  studied  not  only  as  to  the  time  when  paid, 
place  where  paid  and  by  whom  paid,  but  also  as  to  the 
amount  to  be  paid.  Frequently  the  corporate  franchise 
taxes  depend  on  net  earnings  derived  from  operations 
within  the  State.  To  calculate  these  requires  no  little 
skill  and  time.  The  law  should  be  read  carefully,  judicial 
interpretations  examined,  and  then  calculations  should 
be  made  that  will  be  honest  but  which  at  the  same  time 
will  not  impose  any  greater  burden  than  is  intended  by 
the  law. 

The  Federal  income  and  excess  profits  taxes  can  be 
calculated  only  by  one  who  has  made  a  careful  examina- 
tion of  the  laws  and  regulations  and  who  understands 
accounting  principles. 

SURPLUS  AND  DIVIDENDS 

Creation  of  surplus. — The  aim  of  business  is  to  make 
profits,  and  in  the  ordinary  course  of  making  and  selling 
goods  or  services,  profits  should  accumulate.  If  for  the 
present  we  restrict  our  attention  to  the  corporation,  we 
may  inquire  if  there  are  any  ways  in  which  a  surplus  may 
be  built  up  other  than  through  current  operations. 

A  surplus  may  also  be  created  through  the  reappraisal 
of  some  of  the  company's  fixed  assets  or  through  a  sale 
of  them  at  more  than  the  value  at  which  they  have  been 
carried  on  the  books.  A  surplus  may  be  created  through 
the  donation  of  an  asset  or  of  stock,  as  when  a  promoter 
buys  all  the  stock  of  a  company,  pays  for  it  with  a  mine 
or  a  patent  and  then  donates  a  part  of  the  stock  in  order 
that  it  may  be  sold  as  treasury  stock  below  par.    So,  too, 


i62  PRINCIPLES  OF  BUSINESS 

a  surplus  may  be  created  by  the  sale  of  stock  or  bonds 
above  par,  as  in  the  case  of  the  sale  of  bank  stocks.  Still 
another  method  is  to  convert  unnecessary  reserves,  such 
as  reserves  for  depreciation  which  prove  too  large,  by 
transferring  them  to  the  surplus  account.  Moreover,  a 
consolidation  may  start  off  with  a  surplus  inherited  from 
the  constitutents  of  the  consolidation. 

The  fundamental  idea  of  a  surplus  is  an  excess  of  value 
beyond  what  was  originally  contributed  by  the  propri- 
etors. In  a  corporation,  then,  surplus  is  most  easily  con- 
ceived of  as  the  difference  between  the  assets  on  the  one 
hand  and  the  true  liabilities  plus  the  reserves  plus  the  out- 
standing capital  stock  on  the  other  hand. 

Law  of  dividends. — American  law  looks  at  the  surplus 
exactly  as  it  is  described  in  the  preceding  paragraph.  The 
only  question  it  asks,  before  passing  on  the  legality  of  a 
dividend,  is.  Does  the  balance  sheet  show  a  surplus?  If 
it  does,  a  dividend  may  be  declared,  quite  irrespective  of 
the  method  by  which  the  surplus  was  created.  In  Eng- 
land the  question  asked  is,  Does  the  income  statement 
show  a  surplus?  In  England,  for  example,  a  company 
may  have  lost  money  for  a  long  time  and  impaired  its 
capital ;  still,  when  a  fruitful  year  arrives,  a  dividend  may 
be  paid  from  its  profits  without  first  repairing  the  pre- 
vious inroads  into  capital.  In  America,  however,  such 
inroads  would  have  to  be  made  good  before  a  dividend 
could  be  declared. 

Expediency  in  payment  of  dividends. — It  does  not 
follow  that  simply  because  a  company  has  a  surplus  and 
legally  may  declare  a  dividend,  that  it  is  the  best  financial 
practice   to   do   so.     Important   practical   considerations 


FINANCING  163 

are  involved,  and  each  of  these  considerations  must  be 
carefully  weighed. 

Manifestly,  it  would  be  foolish  if  not  iniquitous  to  pay 
a  dividend  if  the  company's  only  surplus  was  derived" 
from  the  sale  of  stock  or  bonds  at  a  premium.  Money 
received  in  this  way  is  intended  to  be  used  for  capital 
purposes — for  buying  land,  or  buildings,  or  machinery, 
— and  should  be  consistently  retained  for  those  purposes. 
Likewise,  a  surplus  derived  from  a  revaluation  of  assets 
should  not  be  used  for  dividends,  for  that  kind  of  sur- 
plus is  too  uncertain.  Who  may  say  that  the  asset  is 
worth  more  than  was  paid  for  it  until  it  is  sold?  And 
when  it  is  sold,  may  not  this  imaginary  surplus  disappear  ? 
Besides,  if  there  is  appreciation  in  certain  assets,  the 
appreciation  is  likely  to  be  offset  by  unrecognized  depre- 
ciation in  other  assets.  The  most  conservative  practice  is 
not  to  create  such  a  surplus,  but  if  it  has  been  created,  it 
should  be  kept  separate  from  the  rest  of  the  surplus  and 
disregarded  entirely  when  considering  dividend  payments. 

A  surplus  derived  from  the  sale  of  assets  for  more  than 
their  book  value  may  be  used  for  dividends — though,  in 
declaring  the  dividend,  the  source  should  be  made  known 
to  the  stockholders — if  the  entire  proceeds  of  the  sale  are 
not  needed  for  the  purchase  of  other  assets  to  replace 
those  sold.  Donated  surpluses  should  be  used  for  the 
purpose  for  which  they  are  contributed — selling  stock 
below  par — and  not  for  dividends.^ 

^  See  Dewing's  Corporate  Promotions  and  Reorganizations,  p.  549 
et  seq.  The  theory  is  that  a  promoter  buys  all  the  stock  of  a  con- 
cern for  a  patent  or  a  mine — this  makes  the  stock  full  paid.  Part 
is  then  donated  back,  and  this  under  the  law  may  be  sold  at  less 
than  par.  If  a  promoter  pays  a  dividend  out  of  this  kind  of  a 
surplus  and  leads  prospective  purchasers  to  believe  that  the  divi- 
dend has  been  earned,  he  is  guilty  of  fraud. 


i64  PRINCIPLES  OF  BUSINESS 

Surpluses  accumulated  out  of  the  earnings  of  a  num- 
ber of  years  are  the  usual  source  of  the  huge  extra  divi- 
dends— the  "melons."  It  is  perfectly  proper  to  "cut 
melons,"  but  they  should  not  come  as  a  surprise.  A 
"melon"  is  apt  to  be  preceded  by  a  long  period  of  low 
dividends  during  which  the  directors  have  surreptitiously 
bought  up  a  lot  of  stock  on  which  they  get  the  income 
from  the  sudden  declaration  of  the  extra  dividend.  Sur- 
pluses inherited  from  the  constituents  of  the  consolida- 
tion should  be  studied  as  they  accumulated  in  the  opera- 
tion of  the  constituent  companies.^ 

In  the  second  place,  the  directors  are  bound  to  look 
out  for  the  welfare  of  the  company.  The  company  may 
be  making  huge  profits,  but  if  it  needs  the  funds  thus 
stored  up  to  push  its  own  business,  the  dividends  may  be 
withheld.^  In  the  third  place  the  interest  of  the  stock- 
holders should  be  served  and  their  interests  demand  regu- 
lar and  early  payment  of  dividends. 

Dividends  and  stockholders. — It  can  be  shown  with 
mathematical  precision  that  the  interest  for  the  first 
twelve  to  fifteen  years  on  a  5  per  cent  or  a  6  per  cent 
bond  is  worth  as  much  as  the  rest  of  the  bond,  principal 
and  interest,  no  matter  how  long  the  bond  has  to  run. 
On  this  principle  it  can  readily  be  shown  that  dividends 

^  Accumulated  surplus  may  also  be  the  result  of  converted  un- 
necessary reserves,  or  of  the  writing  up  of  a  surplus  by  writing 
on  the  books  the  value  of  the  assets  that  theretofore  had  been 
charged  to  expense. 

2  Ordinarily  the  declaration  of  dividends,  from  a  legal  standpoint, 
rests  with  the  directors.  They  cannot  be  compelled  to  declare 
dividends,  unless  the  company  has  convenanted  with  its  stock- 
holders, as  it  sometimes  does  with  the  holders  of  preferred  stock, 
or  unless  it  can  he  shown  that  in  withholding  dividends  the  directors 
are  committing  fraud  on  the  minority  stockho-ders  who  are  power- 
less to  remove  the  self-serving  directors. 


FINANCING  165 

paid  now  are  worth  a  great  deal  more  than  the  promise  of 
dividends  to  come.  Hence,  the  stockholder's  interest 
demands  immediate  payment. 

Moreover,  the  stockholder  desires  regular  payments. 
Much  better. is  it  to  pay  regularly  5  per  cent  a  year  for 
five  years  than  an  aggregate  of  25  per  cent  in  five  years 
in  spasmodic  declarations.  The  former  policy  will  mean 
generally  a  higher  level  of  market  value,  freedom  from 
suspicion  of  manipulation,  and  will  in  general  denote  a 
more  intelligent  managerial  policy. 

Stability  of  dividends. — The  much-desired  stability  of 
dividends  can  be  achieved  partly  as  a  matter  of  general 
business  policy — stimulating  sales  and  reducing  operat- 
ing expenses  in  dull  times,  but  chiefly  as  a  matter  of  finan- 
cial policy.  In  the  first  place,  a  company  should  grad- 
ually build  up  a  fund  for  this  very  purpose,  the  usual 
name  for  such  a  fund  being  ''Dividend  Equalization  Re- 
serve or  Fund."  ^ 

In  the  second  place,  when  accumulated  surplus  or  the 
equalization  reserve  grows  too  large,  an  "extra"  dividend 
may  be  declared.  Labelling  the  dividend  "extra"  calls 
attention  to  the  fact  that  the  dividend  need  not  be  ex- 
pected at  regular  periods.  Such  a  dividend,  moreover, 
should  be  declared  only  after  due  notice  has  been  given  to 
the  stockholders,  otherwise  manipulation  may  be  charged, 
even  if  the  suspicion  is  unfounded. 

Reserve  policies. — But  now  we  must  return  to  the  re- 
lation of  dividend  payments  to  the  welfare  of  the  com- 
pany. 

'Since  a  conservative,  well-managed  company  can  usually  bor- 
row when  necessary,  the  setting  up  of  a  reserve  without  the  actual 
setting  aside  of  a  fund  will  be  sufficient. 


i66  PRINCIPLES  OF  BUSINESS 

It  is  proposed  to  declare  a  dividend  because  the  coHl- 
pany  has  a  surplus  from  which  the  dividend  can  be  de- 
clared. The  question  now  arises,  Should  it  be  paid.  The 
directors  ought  first  to  inquire  whether  all  the  assets  are 
valued  at  or  below  their  true  value.  A  plant  five  years 
old  may  be  carried  on  the  books  at  the  original  value 
though  it  may  have  lost  a  good  part  of  that  value  through 
wear  and  tear.  If  such  has  been  the  case  a  depreciation 
reserve  should  be  set  up  on  the  liability  side  of  the  balance 
sheet  and  a  corresponding  diminution  should  be  made  in 
surplus  account.^  Some  of  the  accounts  or  notes  receiv- 
able may  be  doubtful  or  quite  uncollectible.  To  obviate 
this  difficulty  a  reserve  may  be  set  up  for  bad  debts. 

If  the  business  is  subject  to  any  hazards  that  may  re- 
duce its  assets,  reserves  may  be  set  up  against  these  haz- 
ards or  contingencies.  Whenever  a  loss  so  provided  for 
is  actually  sustained,  the  asset  affected  is  written  off,  the 
reserve  is  reduced  and  no  necessity  will  then  arise  for 
reducing  the  surplus  or  even  for  setting  up  a  deficit 
account  on  the  asset  side.  Beyond  this  it  may  be  wise  to 
go  on  with  the  setting  up  of  reserves  for  special  purposes, 
as  for  working  capital  and  expansion — to  insure  the  re- 
taining of  a  certain  portion  of  the  profits  in  the  business 
and  to  prevent  the  use  of  all  the  cash  and  surplus  for 
dividends — or  for  other  special  purposes,  such  as  for  pen- 
sions for  employees. 

1  When  through  the  failure  of  earnings  in  past  years,  the  capital 
has  been  impaired  and  the  payment  of  dividends  is  impossible  under 
the  law,  the  creation  of  a  fictitious  surplus  is  sometimes  attempted 
by  writing  up  the  assets,  by  creating  a  fictitious  asset  such  as  good- 
will, or  by  reducing  the  capital  stock. 

This  question  is  treated  at  greater  length  in  the  chapter  on 
accounting. 


FINANCING  167 

Dividends  and  cash. — After  the  assets  have  been 
taken  care  of,  there  still  remains  the  question  of  whether 
the  company  can  spare  the  cash.  The  answer  to  that 
question,  of  course,  must  be  sought  in  the  relation  of  cash 
assets  to  current  liabilities.  Unless  the  company  has 
sufficient  cash  to  meet  its  immediate  debts  and  to  take 
care  of  such  demands  as  are  likely  to  arise,  the  directors 
will  do  well  to  postpone  the  dividend  or  to  pay  it  in  some 
way  other  than  in  cash.  If  the  company  has  large  tax 
payments  to  meet,  it  will  do  well  ^?  keep  cash  for  them. 
Or  if  the  company's  business  is  growing  rapidly  it  will 
find  more  working  capital  necessary  and  will  act  wisely 
by  postponing  large  cash  dividends. 

Scrip,  stock  and  property  dividends. — A  company 
that  has  a  large  and  rapidly  accumulating  surplus,  but 
needs  all  the  cash  it  can  get,  may  elect  to  pay  its  dividends 
in  scrip,  stock  or  property.  Scrip  is  nothing  other  than 
an  unsecured  interest-bearing  note.  The  stockholder 
may  sell  it,  and  thus  in  effect  get  his  cash  dividend  im- 
mediately. Stock  dividends  are  used  when  a  company 
has  a  large  earning  power,  but  needs  its  cash  for  the  pres- 
ent. The  effect  is  gradually  to  spread  the  profits  over  a 
large  area  of  stock  and  thus  to  make  dividends  nominal 
and  the  stock  worth  nearer  par.  It  is  generally  found, 
for  example,  if  a  14  per  cenf  stock  sells  at  180,  all  other 
things  being  equal,  a  7  per  cent  stock  will  sell  at  par.  In 
such  cases  it  will  be  wise  to  give  the  stockholders,  through 
a  stock  dividend,  two  shares  of  stock  in  place  of  one  and 
then  to  pay  7  per  cent  dividends  on  both. 

Property  dividends  are  used  in  unusual  cases.  Thus  in 
the  Great  War  a  number  of  powder  and  ammunition  com- 


i68  PRINCIPLES  OF  BUSINESS 

panics  had  purchased  large  amounts  of  Anglo-French 
bonds  which  they  did  not  wish  to  keep  permanently; 
accordingly,  they  paid  out  these  bonds  in  dividends. 

CAPITALIZATION 

Capitalization  and  recapitalization. — In  discussing 
the  question  of  stock  dividends  in  the  previous  paragraph, 
we  hit  upon  the  very  kernel  of  the  question  of  capitaliza- 
tion. Everybody  has  heard  of  the  expression  "watered 
stock."  What  does  it  mean  ?  If  a  company  issues  more 
stock  to  a  promoter  than  the  promoter  returns  in  value  to 
the  corporation,  the  company's  stock  is  said  to  be  watered. 
But  who  is  to  determine  the  value  of  the  thing  turned 
into  the  company  by  the  promoter?  It  may  be  a  mine. 
Is  the  mine  worth  what  the  promoter  paid  for  it  ?^  It 
may  be  worth  a  great  deal  more.  Who  can  say?  John- 
son's famous  reply  when  he  was  asked  how  much  his 
benefactor's  brewery,  which  he  as  executor  was  selling, 
was  worth,  hits  the  nail  on  the  head — "I  am  not  about 
to  sell  a  parcel  of  vats  and  boilers,  but  the  potentiality 
for  growing  rich  beyond  the  dreams  of  avarice.''  Prop- 
erty embarked  in  business  is  worth  more,  as  an  entity, 
than  as  a  group  of  assets  regarded  separately.  Assets 
are  worth,  indeed,  what  they  will  earn  capitalized  at  a 
reasonable  rate.  What  is  a  reasonable  rate  will  depend 
on  the  conditions  surrounding  the  business.  An  earning 
power  based  on  an  ephemeral  demand,  on  a  demand  for 

^  The  legal  questions  involved  are  fairly  simple.  A  promoter 
begins  to  be  a  promoter  from  the  moment  he  conceives  the  idea  of 
forming  the  company.  Property  held  by  him  at  that  time  may  be 
turned  in  at  its  value,  irrespective  of  what  was  paid  for  it.  Prop- 
erty acquired  by  a  promoter  after  that  time  must  be  turned  in  by 
the  promoter  at  what  he  paid  for  it,  irrespective  of  how  much 
more  it  really  may  be  worth. 


FINANCING  169 

luxuries  that  varies  with  the  prosperity  of  the  commu- 
nity, or  on  a  hazardous  undertaking,  is  clearly  not  worth 
as  much  as  an  earning  power  of  $100,000  growing  out  of 
the  production  of  goods  which  satisfy  an  everyday  need 
of  the  people. 

It  is  wise  to  capitalize  on  an  earning-power  basis,  and, 
if  the  earning  power  changes,  to  recapitalize.  The  re- 
capitalization may  take  the  simple  form  of  a  stock  divi- 
dend, or  it  may  be  more  complex.  If,  for  example, 
earning  power  is  high,  but  cash  is  needed,  stock  may  be 
sold  and  partly  paid  with  a  contemporaneously  declared 
dividend. 


CHAPTER    IX 

FINANCING 

(Continued) 

INSOLVENCY,    BANKRUPTCY   AND   REORGANIZATION 

Readjustments. — Sometimes  the  capitalization  in 
stead  of  being  too  low  is  too  high.  Any  form  of  business 
troubles  may  reduce  a  company's  earning  power  to  a  point 
where  it  is  insufficient  to  earn  interest  on  its  bonds,  to 
pay  dividends  on  its  stock,  or  perhaps  even  to  pay  its 
ordinary  debts  as  they  become  due.  The  causes  may  be 
entirely  without  the  corporation,  as,  for  example,  where 
the  demand  for  its  product  slackens,  where  competition 
becomes  destructive  and  its  competitors  have  strong 
financial  backing  to  withstand  a  price  war.  On  the  other 
hand,  conditions  may  arise  inside  the  company,  nearly 
all  of  which  are  traceable  to  bad  management  in  some 
form  or  at  some  time,  that  make  it  necessary  to  readjust. 

A  readjustment  is  a  voluntary  rearrangement  of  owner- 
ship and  creditorship  claims  caused  by  the  failure  of  a 
company,  present  or  prospective,  to  meet  the  claims 
against  it. 

Causes  of  failure. — In  the  previous  paragraph  we 
sketched  in  a  broad  way  the  causes  of  business  failure. 
The  subject  is  so  important  that  we  can  afford  to  go  into 
it  in  detail.  As  was  indicated,  the  failure  may  arise 
without   the  corporation   or  business — from  causes  be- 

170 


FINANCING  171 

yond  control — or  may  be  due  to  perfectly  avoidable  mis- 
takes, or  to  negligence  or  incompetence. 

The  causes  that  are  somewhat  beyond  control  are : 

1.  Changes  in  public  demand.  This  cause  is  avoidable, 
since  a  business  management  ought  to  foresee  the  change 
and  voluntarily  liquidate  or  change  the  line  of  product. 

2.  Competition.  This  cause  is  less  a  difficulty  now 
than  before  the  creation  of  the  Federal  Trade  Commis- 
sion. The  real  danger  is  never  fair,  intelligent  competi- 
tion. This  is  usually  helpful.  The  true  danger  is  unfair 
cornpetition,  and  this  is  now  being  eliminated. 

3.  General  business  depression.  Business  depressions 
are  quite  certain  to  occur,  but  their  evil  efifects  may  be 
avoided  by  competent  business  managers. 

4.  Death  of  important  leaders.  A  one-man  business, 
of  course,  will  die  with  its  master.  Proper  organization 
is  the  only  real  preventive. 

The  causes  that  are  avoidable  are : 

1 .  Ignorance  of  business  principles.  Coupled  with  this 
is  failure  to  apply  the  principles. 

2.  Negligence. 

All  other  avoidable  causes  grow  out  of  these  two  pri- 
mary causes.  The  secondary  causes,  such  as  poor  selection 
of  goods,  insufficient  capital,  and  the  like,  need  no  special 
comment  here.  Fraud,  dishonesty,  theft,  and  the  like, 
while  sometimes  very  real  obstacles  in  the  way  of  business 
success,  need  not  be  treated  here.  Let  it  suffice  to  say 
that  no  business  is  really  sound  and  safe  that  does  not 
rest  on  sound  morality  and  the  universal  rule  of  mutual 
benefit  to  business  and  customers  in  fair  proportion  one 
to  the  other. 


172  PRINCIPLES  OF  BUSINESS 

Embarrassment,  insolvency  and  bankruptcy. — Fre- 
quently a  company  finds  itself  in  desperate  need  of  ready 
funds.  The  total  of  assets  may  be  all  right;  even  earn- 
ing power  may  be  all  right.  The  company  may  have 
taken  on  profitable  contracts,  installed  machinery  to  per- 
form its  contracts,  bought  large  quantities  of  raw  ma- 
terials— all  of  which  means  an  outlay  of  ready  money. 
Whence  shall  come  the  funds  to  meet  the  payroll  ?  Such 
a  concern  is  said  to  be  financially  embarrassed.  It  may 
resort  to  temporary  and  expensive  expedients  to  raise 
cash,  such  as  borrowing  on  its  accounts  receivable,  or 
money  may  be  borrowed  from  private  persons  at  exorbi- 
tant rates. ^  Somehow  it  may  squeeze  through.  If  it 
does  not,  and  actually  has  claims  against  it  that  cannot 
be  met,  it  is  said  to  be  insolvent.  A  concern  is  said  to 
be  insolvent  when  it  cannot  meet  its  debts  as  they  mature 
in  the  ordinary  course  of  business.  If  the  condition  is 
still  worse  and  assets  are  less  than  liabilities,^  the  con- 
cern is  insolvent  under  the  bankruptcy  act  definition  of 
that  term,  and  it  may  be  forced  into  bankruptcy. 

Remedies  for  insolvency. — When  a  company  cannot 
pay  its  debts,  some  action  is  necessary  to  protect  not  only 
the  debtor  company,  but  its  creditors  as  well.  If  nothing 
is  done,  some  of  the  creditors  rhay  sue,  obtain  judgments, 
and  levy  executions  on  the  property  of  the  debtor,  and  sell 
the  property,  usually  at  a  sacrifice,  in  order  to  satisfy  their 
claims. 

The  company  may  have  an  excess  of  assets  over  lia- 
bilities, but  its  assets  may  not  be  in  sufficiently  liquid 

1  In  most  States  a  corporation  can  agree  to  pay  any  rate  of  inter- 
est without  committing  usury. 

2  For  this  purpose  stock  is  not  regarded  as  a  Hability. 


FINANCING  173 

form.  Perhaps  it  has  tied  up  too  much  capital  in  mer- 
chandise that  is  not  moving  rapidly  enough.  In  time, 
however,  this  merchandise  will  be  sold  and  converted  into 
cash  and  the  creditors  probably  paid  in  full.  The  com- 
pany then  should  take  some  appropriate  action  to  prevent 
the  dissipation  of  its  assets  by  insistent  creditors  who 
may  bring  their  claims  to  suit.  If  it  possibly  can  do  so, 
let  the  company  borrow  or  otherwise  raise  additional 
cash  to  tide  it  over  a  period  long  enough  to  permit  the 
sale  of  some  of  its  less  liquid  assets.  This  will  enable 
the  company  to  pay  its  other  debts  and  keep  in  good 
standing  with  the  creditors.  If  this  is  not  possible,  then 
the  debtor  company  would  do  well  to  go  to  its  creditors 
and  ask  them  to  extend  the  due  date  of  the  debts  for  three 
or  six  months,  or  even  a  year.  Such  extensions  credi- 
tors are  very  likely  to  grant,  providing  they  are  satisfied 
that  the  debtor  is  honest  and  has  sufficient  business  ability 
and  financial  strength  to  continue  business  and  finally  ex- 
tricate himself  from  his  present  difficulties.  Some  credi- 
tors, however,  may  even  then  refuse  to  agree  to  the  ex- 
tension; they  may  insist  on  immediate  payment.  If  the 
debts  are  few  in  number  and  small  in  amount,  the  debtor 
would  do  well  to  rid  himself  of  the  creditors  by  paying 
them,  and  he  would  probably  find  that  the  larger  creditors 
would  prefer  this  step  to  the  receivership  w^hich  would 
otherwise  be  necessary.  If  some  of  the  creditors  actually 
start  suits  and  obtain  judgment,  the  debtor  would  do  w'ell 
to  apply  for  a  receiver  and  so  prevent  these  creditors  from 
selling. the  property  and  dissipating  the  assets,  by  this 
means  insuring  the  equitable  treatment  of  all  creditors. 
Indeed,  if  the  debtor  himself  does  not,  under  these  cir- 


174  PRINCIPLES  OF  BUSINESS 

cumstances,  ask  for  a  receiver,  the  other  creditors,  if 
vigilant,  will  do  so. 

Receiverships. — A  receiver  is  an  impartial  person 
appointed  by  an  equity  court  to  hold  property  till  the 
court  can  determine  who  is  entitled  to  it.  Receivership 
proceedings  hold  up  all  executions  and  give  the  creditors 
and  the  debtor  an  opportunity  to  look  about  for  an  easy, 
fair  and  satisfactory  settlement.  If  the  difficulties  are 
merely  temporary,  the  creditors  may  agree  to  give  the 
debtor  additional  time.  If  they  refuse,  the  receiver  may 
be  authorized  by  the  court  to  continue  the  business,  grad- 
ually dispose  of  the  assets  and  pay  off  the  creditors,  and 
finally  when  all  creditors  have  been  taken  care  of,  to 
return  the  business  to  the  debtor. 

Settlements  with  creditors. — Those  are  the  remedies 
when  the  debtor's  difficulties  are  temporary — when  the 
debtor  is  suffering  only  from  a  lack  of  cash.  But  when  a 
debtor's  difficulties  are  more  fundamental — as  when  he 
has  an  actual  excess  of  liabilities  over  assets — some  more 
drastic  remedy  is  needed.  If  the  debtor  has  lost  his  orig- 
inal investment  and  finds  that  his  Habilities  exceed  his 
assets,  he  must  either  obtain  additional  capital  or  reduce 
his  liabilities  without  commensurately  reducing  his  assets. 
Ordinarily  he  will  find  it  exceedingly  difficult,  if  not  im- 
possible, to  obtain  additional  capital  from  outside  sources. 
Practically,  then,  he  must  go  to  his  creditors  and  ask  them 
to  share  part  of  his  losses  by  voluntarily  reducing  the 
debts.  This,  a  so-called  composition  or  common-law 
settlement,  the  creditors  may  agree  to,  providing,  first, 
that  the  debtor  is  honest,  and  second,  that  they  think  they 
will  not  get  much  more  than  the  reduced  amount  of  their 


FINANCING  175 

claims  by  putting  the  debtor  into  bankruptcy.  If  the 
creditors  cannot  agree  to  the  common-law  settlement,  per- 
haps some  method  of  dividing  the  property  may  be  found 
that  will  be  satisfactory  to  all  and  which  will  cost  little 
to  carry  into  execution.  In  order  to  guarantee  his  good 
faith  the  debtor  may  assign  his  property  to  one  of  his 
creditors  or  to  some  other  person  for  the  benefit  of  all 
his  creditors.  If  the  creditors  cannot  agree,  the  failed 
business  will  likely  go  into  bankruptcy. 

Going  into  bankruptcy. — We  have  not  the  space  to  go 
into  a  general  exposition  of  bankruptcy  law  and  proced- 
ure.^    But  a  general  outline  will  not  be  out  of  place. 

Bankruptcy,  as  everybody  knows,  is  a  condition  of  in- 
solvency declared  to  exist  under  the  Federal  Bankruptcy 
Act,  and  accompanied  by  the  administration  of  the  bank- 
rupt's estate  under  the  rules  of  the  statute.  Though,  in 
the  beginning,  bankruptcy  statutes  were  intended  only  to 
aid  creditors  in  being  sure  that  they  got  all  the  debtor's 
property,  they  have  the  further  purpose  now  of  enabling 
a  debtor  to  free  himself  from  debts  honestly  contracted, 
if  there  appears  to  be  no  means  of  meeting  them.  Thus 
the  statute  permits  many  to  become  economically  free, 
after  they  have  encumbered  themselves  with  debts  they 
find  impossible  to  pay. 

The  bankrupt's  property  is  handed  over  to  a  trustee 
and  then  usually  sold,  the  proceeds  being  paid  over 
ratably  to  the  creditors.  The  debtor  is  then  free  from 
all  claims  against  him  (with  few  exceptions,  and  these 
only  in  cases  where  he  has  been  guilty  of  fraud  in  con- 
nection with  his  bankruptcy  proceedings)  that  existed  at 

^  See  Gerstenberg,  The  Law  of  Bankruptcy. 


176  PRINCIPLES  OF  BUSINESS 

the  time  when  the  bankruptcy  proceedings  were  started. 

Bankruptcy  sometimes  is  inevitable.  But  it  does  not 
provide  an  easy  way  out  of  debts.  Better  a  thousand 
times  for  a  debtor  to  pay  his  debts,  to  struggle  to  pay 
them,  than  to  take  the  apparently  easy  course  of  the 
bankruptcy  courts.  True,  even  after  a  debtor  has  been 
discharged  from  debts  that  have  been  only  partly  paid, 
he  may  proceed  voluntarily  to  pay  up  in  full  and  thus 
rehabilitate  his  credit. 

Compositions  with  creditors. — There  is  hardly  a 
time  when  creditors  cannot  hold  up  legal  proceedings  and 
make  a  settlement  of  their  claims  with  an  unfortunate 
debtor.  Thus  the  Bankruptcy  Act  provides  that  prac- 
tically at  any  time  after  proceedings  have  been  begun  a 
majority  of  creditors  may  agree  upon  a  composition 
which  will  be  affirmed  by  the  court  unless  there  has  been 
some  form  of  fraud  in  the  dealings.  A  settlement  that 
cuts  court  costs,  officers'  fees  and  the  like  is  always  advis- 
able, unless,  of  course,  a  fraudulent  debtor  is  to  make 
profit  by  it. 

Who  gets  an  insolvent  debtor's  property? — Many 
of  the  apparently  intricate  rules  of  bankruptcy  law  will 
lose  their  seeming  complexity  if  it  is  remembered  that 
they  generally  rest  on  the  theory  that  from  the  moment 
a  debtor  becomes  insolvent,  in  the  sense  that  his  a.ssets 
are  insufficient  to  pay  his  debts,  his  property  virtually 
belongs  to  his  creditors.  He  cannot  give  it  away,  he 
cannot  even  use  it  to  pay  some  of  his  debts  in  full,  for 
the  Bankruptcy  Act  is  intended  to  prevent  the  preference 
of  certain  creditors  over  others. 

This  does  not  mean  that  mortgages  or  other  liens 


FINANCING  177 

given  before  insolvency  are  avoided,  or  are  rendered  in- 
effective. Were  this  not  true,  all  liens,  such  as  mort- 
gages, mechanics'  liens  and  the  like  would  be  ineffective. 
Ordinarily,  then,  when  a  debtor's  property  is  distributed, 
after  the  costs  of  the  bankruptcy  action  are  paid,  after 
taxes  are  met,  and  certain  claims  for  wages  taken  care  of, 
the  rest  goes  to  creditors,  except  that  creditors  with  estab- 
lished liens  may  specifically  have  the  property  on  which 
they  have  been  relying. 

We  can  but  repeat  what  is  said  in  the  chapter  on  col- 
lections— the  diligent,  forehanded  creditor  is  the  one  who 
wins  out.     Eleventh  hour  shrewdness  is  unavailing. 

REORGANIZATIONS 

Reorganization. — There  are  certain  large  businesses 
that  fail  but  that  do  not  go  into  the  bankruptcy  courts. 
The  doors  of  these  courts  may  be  closed,  either  because 
the  debtor  has  not  committed  a  so-called  act  of  bankruptcy, 
or  is  not  insolvent  in  the  sense  that  the  assets  are  less 
than  the  liabilities,  or  because  the  debtor  is  a  railroad  or 
moneyed  concern  such  as  a  bank  or  insurance  company, 
which  under  the  bankruptcy  laws  may  not  be  put  into 
bankruptcy.^  Such  concerns  very  frequently  represent 
huge  sums  of  capital  that  must  be  kept  together.  To  break 
up  the  plants  and  sell  the  machinery  and  the  rest  of  the 
property  in  separate  parcels  would  simply  mean  the  loss 
of  the  most  valuable  asset  of  all — the  organization  of  the 
parcels  into  a  money-making  machine. 

^  Large  concerns  frequently  come  under  the  class  of  concerns  that 
are  insolvent  in  the  sense  of  being  unable  to  pay  delXs  as  they 
mature,  but  of  having  sufficient  assets,  at  a  fair  value,  to  offset  the 
debts.  A  concern  cannot  be  put  into  bankruptcy  unless  the  insol- 
vency is  one  of  the  balance-sheet  variety. 


178  PRINCIPLES  OF  BUSINESS 

Such  concerns  are  generally  reorganized.  Here  again 
we  shall  be  compelled  to  give  only  a  very  brief  descrip- 
tion of  reorganization  principles. 

Purposes  of  reorganization. — Reorganizations  have 
three  main  purposes : 

1.  Obviating  the  difficulties  that  made  the  reorganiza- 
tion necessary. 

2.  Supplying  the  funds  needed  to  give  the  reorganized 
company  a  fair  start. 

3.  Assuring  a  safe  management  that  will  see  the  com- 
pany through  its  period  of  difficulty. 

Obviating  the  difficulties. — The  main  causes  of  fail- 
ure— perhaps  we  should  say  the  immediate  causes,  for 
there  may  be  other  causes  of  which  the  primary  causes 
are  the  effect — the  primary  causes  of  failure  are  over- 
capitalization, especially  in  the  matter  of  bonds,  low 
earnings,  or  unwieldy  floating  debt.  As  we  pointed  out 
inferentially  in  the  section  on  capitalization,  overcapital- 
ization and  low  earnings  are  really  one  and  the  same 
thing.  The  difference  is  merely  one  of  time — a  com- 
pany may  start  out  overcapitalized  and  then  it  will  be- 
come apparent  that  its  earnings  are  too  low  to  sustain  the 
capitalization.  On  the  other  hand,  the  original  capital- 
ization may  be  satisfactory  but  the  earnings  may  drop. 
Then  it  becomes  apparent  that  the  old  capitalization  is 
too  high  to  be  sustained  by  the  new  low  level  of  earn- 
ings. In  either  case,  the  one  remedy  is  to  reduce  the 
capital  charges.  The  best  way  of  doing  this  ordinarily 
is  to  combine  the  following  expedients : 

I.  To  combine  small  underlying  bonds  into  a  single 
large  issue  with  a  low  interest  rate. 


FINANCING  179 

2.  To  combine  junior  mortgages  (that  is  second,  third, 
etc.,  mortgages)  into  a  fairly  low-interest-bearing  second 
mortgage,  or  convert  them  into  preferred  stock. 

3.  To  change  the  contingent  charges  of  preferred  stock 
into  the  simple  claim  of  common  stock. 

Furnishing  funds. — Sometimes,  as  was  pointed  out  in 
a  previous  paragraph,  the  difficulty  arises  from  a  burden- 
some floating  debt  that  hampers  the  company  and  eats 
up  all  current  available  funds.  The  debt,  possibly,  was 
incurred  to  pay  for  fixed  assets  that  should  have  been 
purchased  from  the  proceeds  of  the  sale  of  stock  or 
bonds.  The  company  may,  in  its  reorganization,  per- 
suade the  holder  of  this  floating  debt  to  accept  bonds  in 
payment.  Ordinarily,  however,  under  a  well-established 
equitable  doctrine,  the  holders  of  the  floating  debt  have 
a  claim  better  than  that  of  the  bondholders  and  they  can 
therefore  insist  upon  cash. 

The  company  may  have  need  of  funds,  moreover,  to 
assist  in  its  operation  after  reorganization.  Lack  of 
funds  is  apt  to  cause  all  kinds  of  ineconomies,  and  it  is 
just  these  that  the  reorganization  is  attempting  to  eradi- 
cate. 

Evidently,  the  reorganized  company  has  no  general 
credit.  The  public  would  not  subscribe  largely  to  its 
stock  or  bonds.  The  money  must  be  forthcoming  from 
the  old  security-holders — those  who  have  a  stake  to  lose. 
And  the  more  certain  they  are  to  lose  it — the  easier  it  is 
to  freeze  them  out — the  more  money  can  be  expected 
from  them  to  save  their  stake. 

Forcing  funds. — In  accordance  with  these  ideas  it  is 
usual   to   foreclose   one   of  the   senior   mortgages,   thus 


i8o  PRINCIPLES  OF  BUSINESS 

wiping  out  the  interests  of  all  succeeding  securities.  At 
the  foreclosure  sale  the  property  is  bought  in  for  a  new, 
reorganized  company — the  X  Railway  Company,  per- 
haps, if  the  old  company's  name  was  the  X  Railroad 
Company — and  then  stock  and  bonds  are  issued  by  this 
company  to  all  those  who  have  put  up  the  necessary  funds. 
It  is  usual  to  let  the  holders  of  first-mortgage  bonds  take 
first-mortgage  bonds  in  the  new  company,  but  the  holders 
cf  inferior  claims  and  the  holders  of  stock  are  usually 
required  to  pay  an  assessment  as  the  price  of  admission 
to  the  new  company.  Then  the  assessment  is  recognized 
by  the  issue  of  bonds  for  approximately  the  same  amount, 
and  the  general  claim  of  the  security  holder  is  recognized 
by  issuing  some  stock — preferred  or  common. 

TYPICAL   REORGANIZATION 

Technique  of  reorganization. — Having  in  a  general 
way  sketched  the  aims  of  a  reorganization,  we  may  now 
go  back  and  outline  the  practice  usually  followed  in  at- 
taining these  ends. 

In  the  first  place,  to  prevent  conflicting  claimants  from 
seizing  property,  a  receiver  is  applied  for.  This  puts 
the  custody  of  the  property  in  the  hands  of  the  court  and 
preserves  the  property  as  a  unit  till  the  conflicting  claim- 
ants can  agree  upon  a  plan  of  reorganization.  The  vari- 
ous claimants  then  form  committees,  the  moving  spirits 
in  the  committees  being  the  bankers  who  originally  sold 
the  issues,  or  the  bankers,  insurance  companies  and  others 
who  hold  large  quantities  of  the  issue.  Thus  there  may 
be  five  or  six  committees  that  will  eventually  be  repre- 
sented about  the  "peace  table."     In  order  to  assure  that 


FINANCING  i8r 

what  the  committee  thinks  is  right  will  be  agreed  to  by  all 
the  other  holders  of  the  same  securities,  the  committees 
advertise  for  "deposit  of  securities."  This,  in  effect, 
means  that  the  depositing  security-holders  constitute  their 
committee  their  plenipotentiary  attorneys  to  look  out  for 
their  interests. 

Then  comes  the  "jockeying  for  position"  by  the  com- 
mittees. It  must  not  be  thought  that  the  arrangement  of 
interests  in  the  new  reorganized  company  is  a  simple 
matter,  dependent  entirely  on  legal  principles.  Indeed, 
in  many  instances  economic  problems,  the  answers  to 
which  must  come  from  competent  engineers  and  account- 
ants, determine  the  new  alignment.  A  simple  example 
must  suffice.  Suppose  A  bonds  have  a  first  mortgage  on 
property  A,  and  a  second  mortgage  on  property  B,  while 
B  bonds  have  a  first  mortgage  on  property  B  and  a  second 
mortgage  on  property  A.  From  the  legal  point  of  view, 
these  bonds  are  on  an  even  footing — each  being  secured 
by  a  first  and  a  second  mortgage.  But  if  property  A  has 
greater  earning  power  than  his  property  B,  clearly  the  A 
bondholders  are  in  a  better  strategical  position  than  are 
the  B  bondholders.  To  decide  these  questions  it  is  cus- 
tomary to  get  an  engineering  and  accounting  report  on 
the  value  and  earning  power  of  the  different  parts  of  the 
company. 

When  most  of  the  committees  have  agreed  upon  a  plan, 
it  is  put  into  execution  by  means  of  a  foreclosure  sale. 
A  new  company  is  formed  pursuant  to  the  plan,  and  those 
who  agree  and  do  what  is  required  of  them  get  interests 
in  the  new  company. 

Since  it  is  essential  to  the  success  of  the  reorganized 


i82  '  PRINCIPLES  OF  BUSINESS 

company  that  practically  all  the  interests  agree  and  come 
into  the  new  company,  paying  such  assessments  as  are  re- 
quired of  them,  it  is  usual  for  a  banking  syndicate  to 
underwrite  these  assessments,  the  underwriting  agree- 
ment providing  that  for  a  certain  compensation  in  stocks 
and  bonds,  the  underwriters  will  pay  the  assessments  of 
all  the  old  security-holders  who  do  not  come  in. 

Providing  a  good  management. — The  reorganization 
must  look  forward  to  permanent  success,  and  this  can  be 
had  only  with  wise  and  competent  management.  To  get 
this,  it  is  usual  to  use  the  device  of  the  voting  trust.  The 
voting  stock  of  the  new  company  is  issued  to  trustees, 
who  in  turn  issue  receipts,  in  the  form  of  certificates  to 
those  who  otherwise  would  be  entitled  to  the  stock.  This 
leaves  the  stock  in  the  hands  of  the  trustees,  and  they 
select  competent  managers.  When  dividends  are  paid, 
they  come  in  theory,  at  least,  first  to  the  voting  trustees, 
who  pay  them  over  to  the  holders  of  their  certificates. 
The  certificates  are  as  negotiable  as  stock,  and  are  dealt 
in  on  the  exchanges.  Usually  the  voting  trust  is  contin- 
ued by  the  voting  trust  agreement  for  a  time  sufficiently 
long  to  insure  the  success  of  the  reorganized  company 
and  perhaps  the  liquidation  of  its  bonded  indebtedness. 

BIBLIOGRAPHY 

Lyon,  Hastings,  Capitalisation. 

Lyon,  Hastings,  Corporation  Finance. 

Meade,  E.  S.,  Corporation  Finance. 

Gerstenbcrg,  C.  W.,  Materials  of  Corporation  Finance. 

Dewing,  A.,  Corporate  Promotions  and  Reorganizations. 

Ignatius,  M.  B.,  Financing  of  Public  Service  Corporations. 

Ripley,  W.  L,   Railroad  Finance  and  Organization. 

Daggett,  S.,  Railroad  Reorganization. 

Cleveland  &  Powell,  Railroad  Finance. 

Chamberlain,   L.,    The   Principles  of  Bond  Investment. 

Jordan,   David   F.,  Jordan   on  Investments. 

Sevier,   William,   Danger  Signals. 

Cleveland,  F.  A.,  Funds  and  Their  Uses. 


CHAPTER  X 

MANAGEMENT 

The  problem  of  management. — In  Chapter  VI  of  this 
book  will  be  found  a  brief  description  of  the  various 
classes  of  business  organizations,  including  individual 
proprietorships,  partnerships  and  corporations.  In  the 
chapter  referred  to,  the  organization  of  business  enter- 
prises is  considered  primarily  with  respect  to  the  problem 
of  the  distribution  of  income,  risk  and  control  among  the 
owners  of  the  capital  used  by  the  business.  In  the  present 
chapter  we  must  consider  the  internal  organization  of  the 
business  enterprise,  primarily  with  respect  to  the  de- 
termining of  its  policies,  the  making  of  its  plans,  and  the 
means  whereby  these  policies  and  plans  may  be  put  into 
execution  or  operation. 

Management,  in  brief,  is  the  conducting  of  the  busi- 
ness enterprise;  it  consists,  on  the  one  hand,  of  organ- 
izing, or  planning;  and,  on  the  other  hand,  of  adminis- 
tration— that  is,  of  putting  the  plans  into  effect.  Or- 
ganization and  administration,  accordingly,  are  seen  to 
be  phases  of  management,  corresponding  very  closely  to 
planning  and  performance. 

From  the  very  inception  of  a  business  enterprise  man- 
agement comes  into  play.  In  its  earlier  stages,  however, 
it  is  usually  called  ''promotion"  or  "organization," — 
management  being  regarded  as  the  directing  of  an  estab- 
lished business.     In  the  directing  of  an  established. busi- 

183 


i84  PRINCIPLES  OF  BUSINESS 

ness,  obviously,  organization  goes  on  continuously  and 
is  a  part  of  management.  There  is  no  essential  difference 
between  the  first  assemblage  and  correlation  of  the  parts 
of  a  business,  commonly  called  organization,  and  the 
subsequent  re-correlations  in  the  adding  of  new  depart- 
ments, new  men,  new  machines  and  new  markets,  com- 
monly looked  upon  as  coming  within  the  province  of 
management. 

The  problem  of  management  of  the  business  enter- 
prise is  that  of  the  gathering  together  of  whatever  profit- 
yielding  elements  can  be  found,  and  of  combining  these 
elements  and  directing  them  in  such  a  manner  as  to 
secure  for  the  business  as  an  entity  the  greatest  amount 
of  profit.  These  profiti-yielding  elements,  in  general 
terms,  are  goods  supplied  by  the  capitalist,  labor  by  the 
employee,  purchasing  power  exercised  by  the  public,  and 
managerial  ability  supplied  by  the  manager  or  adminis- 
trator. These  are  the  four  elements  out  of  which  a 
business  enterprise  is  formed.  Goods  without  the  appli- 
cation of  labor  are  of  no  value ;  labor  without  goods  upon 
which  to  expend  itself  is  of  no  value;  the  product  of 
goods  and  labor  without  a  market  is  of  no  value;  and 
the  market  without  the  product  cannot  exist.  Goods, 
labor  and  market  cannot  come  together  of  their  own 
accord — they  must  be  brought  into  relation  each  with 
the  other.  The  person  who  brings  these  several  elements 
together  is  a  "promoter" ;  if  he  continues  their  correla- 
tion and  co-ordination,  he  is  known  as  an  "enterpriser"; 
the  exercise  of  the  enterpriser's  function,  immediate  or 
delegated,  is  defined  herein  as  management. 

Location  of  plant. — The  physical  location  of  the  plant 


MANAGEMENT  185 

of  a  business  is  a  factor  that  affects  the  success  of  the  en- 
terprise very  directly.  For  example,  a  concern  located 
within  easy  distance  of  the  market  for  its  products  may 
make  a  fair  profit,  whereas  one  at  a  greater  distance  or 
located  on  a  poor  railroad  or  away  from  water  connec- 
tions with  the  market  may,  with  better  management,  use 
up  its  profits  in  transportation  charges.  The  accompany- 
ing chart  shows  at  a  glance  the  various  considerations 
that  enter  into  the  solution  of  the  problem  of  economic 
plant  location.  A  few  of  the  considerations  are  not  so 
self-explanatory  that  an  exposition  is  altogether  unneces- 
sary. 

In  studying  the  proximity  of  a  prospective  location  to 
raw  materials,  the  product  must  be  analyzed  and  the  im- 
portance of  each  ingredient  ascertained  and  its  source  lo- 
cated. The  strategic  value  of  the  location  will  depend 
on  its  proximity  to  the  raw  material  of  cheaper  grade  on 
which  transportation  in  relation  to  quality  is  highest. 
Moreover,  the  raw  materials  available  must  be  of  a  grade 
suitable  for  the  particular  grade  of  product  it  is  contem- 
plated manufacturing. 

The  market  should  not  only  be  close  at  hand,  but  should 
extend  about  the  location  in  all  directions.  Ordinarily, 
transportation  charges  will  be  saved  if  a  location  in  the 
center  of  the  market  is  chosen. 

Perhaps,  as  was  indicated  above,  no  CQnsideration  is 
more  important  than  that  of  transportation  facilities. 
These  facilities  should  be  studied  carefully  as  they  affect 
general  distribution. of  the  product  and  as  they  affect  eco- 
nomic operation  of  the  plant.  Hauling  coal,  for  ex- 
ample, from  the  railroad  to  the  plant  is  a  great  disad- 


i86 


PRINCIPLES  OF  BUSINESS 


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MANAGEMENT  187 

vantage  when  we  consider  the  convenience  of  bringing 
coal  cars  directly  from  the  mine  on  elevated  tracks  di- 
rectly over  the  coal  bins  of  the  plant. 

Labor  supply  sometimes  is  greater  at  one  season  than 
at  another.  A  plant  should  not  be  located  where  it  will 
have  to  make  its  strongest  bid  for  labor  in  competition 
with  other  plants  having  the  same  seasonal  demands. 
Moreover,  some  consideration  should  be  given  to  the  at- 
tractiveness of  a  place  to  the  laboring  classes.  Is  the 
locality  healthful;  is  the  water  good;  are  the  social  con- 
ditions good  or  is  the  town  controlled  by  vicious  poli- 
ticians; are  there  distractions  that  may  take  away  em- 
ployees— these  are  questions  that  must  be  considered 
carefully.  If  the  prospective  location  is  near  other  places 
doing  a  business  similar  to  that  of  the  enterprise  in  ques- 
tion the  proper  degree  of  skill  will  likely  be  obtainable. 

The  power  question  hinges  on  the  proximity  to  direct 
water  facilities,  to  the  coal  fields  or  to  hydro-electric  de- 
velopments. 

The  banking  facilities  must  be  taken  into  consideration 
in  connection  with  the  generally  prevailing  banking  laws 
that  banks  can  loan  to  one  concern  amounts  not  in  excess 
of  a  certain  proportion  of  the  capital  and  surplus  of  the 
bank. 

In  studying  the  legal  restrictions  to  which  an  industry 
may  be  subjected,  the  laws  of  the  State  relative  to  hours 
of  labor,  wage  payments  and  employees'  liability  should 
be  investigated. 

While  some  people  always  act  on  the  principle  that  a 
thing  that  costs  nothing  is  worth  nothing,  the  special  in- 
ducements offered  by  some  localities,  such  as  free  factory 


i88  PRINCIPLES  OF  BUSINESS 

sites,  loan  of  capital  for  building  purposes  or  special  tax 
rates  may  well  influence  the  managers  in  selecting  one  of 
several  locations  where  the  other  considerations  are  all 
equal.  Certainly  no  location  should  be  chosen  which 
does  not  give  room  for  almost  unlimited  expansion.  This 
last  consideration  explains  the  establishment  of  such 
mushroom  cities  as  Gary,  Indiana. 

Unity  of  control  essential  in  management. — Busi- 
ness enterprises,  of  course,  are  conducted  on  a  smaller 
scale  than  is  a  world  war,  but  in  the  one  as  in  the  other 
there  is  an  advantage  to  be  derived  from  centralized  con- 
trol. The  business  enterprise,  like  an  army,  must  have  a 
head.  We  have  no  means  of  knowing  what  would  have 
happened  if  America  and  the  Allies  had  continued  to 
face  Germany's  single  control  with  a  divided  control, 
but  the  turning  point  of  the  war  seems  to  have  been  upon 
the  giving  of  supreme  command  to  General  Foch.  One 
pilot  is  better  than  two  for  a  ship,  although  the  two  may 
be  quite  equal  to  each  other  in  skill.  So  in  the  guiding 
of  a  business  enterprise,  there  must  be  a  single  manager 
at  the  helm.  This  is  not  to  say  that  the  manager  may 
be  self-sufficient  and  arbitrary  in  his  course,  but  that  in 
view  of  the  situation  as  it  appears  to  him  at  the  given 
time,  enlightened  by  counsel  and  information  from  many 
sources,  he  must  make  the  final  decision.  He  must  esti- 
mate the  interaction  upon  each  other  of  all  the  determin- 
able factors  in  the  problem  and  thus  forecast  the  results 
of  alternative  combinations  of  factors,  and  must  choose 
the  combination  which  seems  to  him  the  best. 

The  business  enterprise,  then,  must  be  controlled  by 
the  management — and  not  by  the  capitalist  interest,  or 


MANAGEMENT  189 

the  labor  interest,  or  the  pubHc  interest.  The  pur- 
pose of  the  business  is  the  creation  of  the  greatest 
total  of  new  values — that  is,  the  largest  gross  profit, 
so  to  speak,  which  profit  is  to  be  distributed  as  interest 
to  the  capitalist,  wages  to  the  laborer,  various  savings  or 
benefits  to  the  public,  and  the  residue,  commonly  known 
as  "profits,"  to  the  enterpriser,  who  may  or  may  not  be 
the  active  manager.  If  he  is  the  active  manager,  he  may 
pay  himself  a  salary  as  manager  before  calculating  his 
profit  as  enterpriser.  It  is  to  the  interest,  accordingly, 
of  all  who  contribute  to  the  formation  and  operation  of 
the  business  enterprise,  whether  their  contribution  be 
capital,  services  or  patronage,  to  consent  to  a  unified 
control,  exercised  by  the  management,  leaving  questions 
of  the  distribution  of  the  proceeds  of  the  business  to 
be  dealt  with  as  a  separate  problem.  We  cannot  here 
digress  to  enter  upon  a  discussion  of  the  fair  distribution 
of  the  gains  resulting  from  the  operation  of  the  business 
enterprise  further  than  to  make  note  of  a  point  which 
is  of  importance  in  our  consideration  of  management — • 
that  while  under  the  law  the  owners  of  the  business  en- 
terprise include  only  those  who  own  or  control  the  capital 
employed  in  the  business,  under  public  opinion — a  power 
in  many  respects  superior  to  the  law — all  who  contribute 
to  the  operation  of  a  business  have  a  right  to  receive  a 
fair  share  in  the  distribution  of  the  proceeds  of  the  busi- 
ness. Thus  public  opinion  demands  that  capital  receive 
a  fair  return,  the  laborer  a  fair  wage  and  the  public  fair 
service  and  fair  dealing.  The  insistence  of  public  opinion 
upon  these  "fair'  distributions  as  a  "right"  of  the  in- 
terest involved  implies  that  these  interests  are  for  prac- 


I90  PRINCIPLES   OF  BUSINESS 

tical  purposes  proprietary  interests  in  the  business  enter- 
prise. Tlie  manager,  then,  as  we  have  already  noted, 
must  not  conduct  the  business  to  the  advantage  of  one 
interest  to  the  exclusion  of  the  advantage  of  the  other 
interests,  but  must  regard  first  the  prosperity  of  the  busi- 
ness as  itself  an  entity,  to  the  ultimate  benefit  of  capital, 
labor,  and  the  public. 

The  distribution  of  managerial  authority. — We  may 
assume,  then,  that  the  component  parts  of  the  business 
enterprise  have  been  brought  together  and  must  now  be 
correlated  in  such  a  manner  that  the  authority  held  and 
exercised  by  the  manager  can  be  applied  to  each  unit  of 
the  business  structure.  The  manager  himself  can  be  in 
immediate  touch  with  only  a  very  few  of  the  units  at 
any  given  time,  yet  each  unit  must  at  all  times  be  subject 
to  his  direction — otherwise  it  ceases  to  be  a  part  of  the 
organization.  The  manager  must  delegate  or  distribute 
the  requisite  authority  along  certain  lines,  direct  or  in- 
direct, which  reach  finally  to  the  farthest  unit  of  the 
business.  The  direction  or  course  of  these  lines  of  au- 
thority determines  the  internal  form  of  organization — 
whether  it  shall  be  of  the  "traditional"  form,  or  the 
/'functional,"  and  also  whether  the  type  of  management 
shall  be  known  as  "unsystematized,"  "systematized,"  or 
"scientific." 

In  the  next  chapter  we  shall  consider  briefly  the  sev- 
eral types  of  "management";  the  remainder  of  the  pres- 
ent chapter  will  be  devoted  to  a  description  of  the  several 
so-called  forms  or  types  of  internal  "organization."  In 
the  explanations  which  will  be  made  of  the  various  types 
the  illustrations  are  taken  for  the  most  part  from  works 


MANAGEMENT 


191 


Ar'^^^c 


Authority  in  the  Business  Enterprise 

SHOWING    subordination    OF   DETAIL 

All  operations  segregated  into  planning  and  performance.   Plans 
put  into  execution  only  after  approval  by  the  designated  authority. 

Standardized    routine   operations   go    direct    from   planning   into 
performance;   others,  of  varying  importance,   to  department  heads 
general  manager,  or  even  to  stockholders  or  to  the  charter  itself'. 

Problem  of  management  is  to  short-circuit  these  lines  of  au- 
thority (indicated  by  the  arrows)  by  means  of  standardization, 
keeping  detail  in  the  outer  circles  and  leaving  higher  officials  free 
to  deal  with  the  larger  plans  and  policies. 


192 


PRINCIPLES  OF  BUSINESS 


organization,  since  it  is  in  the  "production  department" 
that  the  best  examples  are  to  be  found.  The  principles 
illustrated,  however,  are  applicable  to  the  organization  of 
any  department. 

The  "line"  type  of  organization. — The  "line"  type 
of  organization  is  the  traditional  form ;  it  is  known  also 
as  the  "military,"  "fractional"  or  "numerical"  type.  In 
such  an  organization  we  may  have  for  example,  groups 
of  workmen,  each  group  under  the  entire  control  of  a 
gang  boss,  the  gang  bosses  under  a  foreman,  the  foremen 
under  superintendents,  the  superintendents  under  de- 
partment heads,  and  the  department  heads  under  the  gen- 
eral manager. 


GENERAL  MANAGER 

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Works  Manager 

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>.Men' 

^en. 

lien 

LINE    C 

)RG 

A 

NIZATK 

)N 

The  line  organization  provides  an  excellent  system  for 
the  giving  of  orders  and  for  the  fixing  of  responsibility. 
If  the  man  at  the  head  of  such  an  organization  were  all- 
wise,  and  if  his  subordinates  were  competent  to  execute 
the  orders  as  they  are  transmitted  and  re-delegated  down 


MANAGEMENT  193 

the  line,  the  simplicity  of  this  type  would  go  far  toward 
offsetting  certain  disadvantages  arising  from  the  fact 
that  the  line  organization  is  not  adapted  to  an  economical 
division  of  labor.  Unfortunately,  however,  the  manager 
cannot  be  all-wise,  and  his  department  heads  and  fore- 
men cannot  have  the  scope  of  knowledge,  skill  or  train- 
ing, the  "all  round"  ability,  which  they  need  if  they  are 
to  have  full  charge  of  a  section  of  the  business.  Hiring 
men,  teaching  them,  settling  disputes,  repairing  ma- 
chinery, ordering  material,  planning  the  current  work — 
these  are  a  few  of  the  duties  that  may  require  the  fore- 
man's attention,  all  at  the  same  time,  and  as  Sir  Boyle 
Roche  observed,  "No  man  can  be  in  two  places  at  once, 
barrin'  he's  a  bird."  The  duties  of  the  manager  himself 
are  equally  varied,  and  demand  for  their  most  satisfac- 
tory accomplishment  a  range  of  knowledge  and  ability 
which  no  one  man  may  hope  to  possess.  The  result  is, 
in  the  line  type  of  organization,  that  the  manager  must 
make  many  wrong  decisions,  and  neglect  much  that  is 
important  for  what  is  unimportant.  The  making  of 
costly  mistakes  is  inevitable,  and  so  is  the  issuance  of 
instructions  that,  because  of  the  limited  knowledge  of 
the  manager  when  he  prepares  the  instructions,  cannot 
possibly  be  carried  out.  The  subordinates,  however,  are 
held  responsible  for  executing  the  orders  which  have  been 
so  issued,  and  the  burden  is  put  upon  them  of  finding 
means  of  attaining  the  result  which  is  required.  That 
there  must  be  an  indefinite  amount  of  wasted  energ^^ 
under  such  a  system  is  so  obvious  as  to  require  no  further 
discussion. 

Division  of  labor  in  the  line  organization.^ — As  we 


194  PRINCIPLES  OF  BUSINESS 

• 

have  seen,  the  workmen  in  a  line  organization  are  ar- 
ranged in  groups,  each  group  under  the  entire  control  of 
a  gang  boss  or  a  foreman.  The  foreman  is  responsible 
for  the  satisfactory  completion  of  whatever  work  is  as- 
signed to  himself  and  his  groups  of  workmen;  the  shop 
may  be  a  large  one,  and  many  different  kinds  of  work 
may  be  carried  on  within  it  at  the  same  time^  by  the 
same  men  under  the  same  foreman.  The  disadvantages 
of  such  a  system  are  obvious  and  have  been  touched 
upon  in  the  preceding  paragraphs.  Especially  with  the 
increase  in  size  of  such  a  shop  is  it  difficult  to  find  com- 
petesnt  foremen  and  competent  workmen.  It  does  no 
good  to  discharge  them,  for  sufficiently  capable  men  are 
not  to  be  found. 

Records  in  the  line  organization. — It  is  evident  that 
with  the  same  men  engaged  in  a  great  variety  of  activ- 
ities, the  keeping  of  accurate  records  is  much  more  diffi- 
cult than  if  the  men  were  employed  at  uniform  tasks. 
Especially  when  a  piece-work  wage  system  is  used,  it  is 
difficult  to  get  the  men  to  keep  accurate  records  of  the 
time  taken  with  each  part  of  the  process.  Consequently, 
while  the  total  cost  of  a  job  may  be  known — although 
the  figures  cannot  be  exact,  since  arbitrary  values  must 
be  given  to  overhead  and  other  Indeiermlnable  factors — 
the  records  are  useful  chiefly  from  the  historical  stand- 
point, and  may  be  of  some  value  for  consulting  in  order 
to  determine  the  probable  total  cost  of  another  job  to  be 
performed  under  similar  conditions.  Such  records  can- 
not show  accurately  if  at  all  the  items  which  compose  the 
total  cost.  We  may  know  that  5  is  the  sum,  but  may 
have  no  means  of  finding  out  whether  that  particular  5 


MANAGEMENT  195 

represents  2+2+1,  2-\-i-\-2,  1+2+2,  or  3+1 +1.  The 
consequence  is,  that  improvements  are  largely  accidental 
rather  than  the  result  of  definite  action,  for  until  we  have 
a  means  of  making  analyses  of  production  costs  we  m.ust 
have  only  an  indefinite  idea  of  what  those  costs  are  and 
of  how  they  could  be  reduced. 

Summary. — The  line  organization,  then,  has  the  ad- 
vantage of  original  simplicity;  it  follows  the  lines  of  least 
resistance.  Authority  is  distributed  easily,  and  respon- 
sibility is  fixed  definitely.  This  form  does  not,  however, 
lend  itself  to  the  improvement  of  working  methods,  and, 
moreover,  lacks  the  mechanism  whereby  men  of  excep- 
tional ability  are  given  recognition  and  promotion.  Good 
work  may  go  unnoticed,  since  record-keeping  is  usually  of 
a  primitive  form,  and  there  is  even  a  positive  obstacle 
in  the  way  of  the  good  workman's  progress — the  jeal- 
ousy of  his  immediate  superior,  who  may  fear  that  the 
man  is  "after"  his  own  job.  The  natural  tendency  of  the 
lesser  officers  of  an  organization  is  to  keep  the  workmen 
under  them  somewhat  at  the  same  level — discharging  the 
worst,  and  discouraging  or  repressing  the  best.  In  spite 
of  these  obvious  advantages,  the  line  type  is  still  by  far 
the  most  common  form,  especially  among  the  smaller 
business  organizations. 

Line-and-stafT  organization. — With  the  need  for  the 
correlation  of  a  business  with  its  environments,  com- 
mercial and  scientific,  the  line-and-staff  type  of  organi- 
zation has  been  developed.  Essentially,  this  type  is 
merely  the  Hne  organization  assisted  by  "staff"  advice, 
the  "staff"  consisting  of  experts  such  as  engineers,  chem- 
ists or  other  specialists  who  investigate  the  problems  of 


196 


PRINCIPLES  OF  BUSINESS 


the  business  and  make  recommendations  which  the  man- 
agement may  or  may  not  accept.  Such  staff  assistance 
may  be  given  at  any  part  of  the  Hne,  from  manager  to 
foreman,  but  this  must  be  noted  carefully:  The  im- 
provements suggested  by  the  staff  must  not  be  applied 
except  after  approval  and  assimilation  by  the  proper  au- 
thority. In  other  words,  suggestions  or  recommenda- 
tions must  be  brought  to  the  designated  authority  and 
there  checked  up,  accepted  or  rejected,  and  from  there 
returned  to  the  line  to  become  a  part  of  the  organization. 
If  this  were  not  insisted  upon,  confusion  would  result, 
methods  apparently  improved  as  to  one  part  of  the  proc- 
ess might  involve  disarrangement  or  loss  in  the  suc- 
ceeding stages. 


GENERAL  MANAGER 


Chief  Engineer      ""i    Works  Manager 


I 


Chief  Chemist 


Sup*ts,Foremen,eLc..as  in  Line  chart  above 


LINE     AND     STAFF    ORGANIZATION 


The   departmental   type   of  organization. — It   was 

noted  that  a  disadvantage  of  the  line  organization  is  in 
the  fact  that  the  foreman  or  other  official  is  not  able  to 
"keep  up"  with  the  growth  of  his  department.  Good 
"all  round"  men  are  hard  to  find,  and  even  if  secured 
they  soon  have  so  many  duties  given  to  them  that  they 
cannot  perform  them  all.     An  attempt,  and  a  quite  sue- 


MANAGEMENT 


197 


cessful  and  practical  one,  is  made,  in  the  departmental 
type  of  organization,  to  overcome  the  trouble  alluded 
to  above.  The  essential  principle  of  departmental  or- 
ganization is  a  sort  of  group  specialization,  in  which  a 
foreman  and  his  gang,  selected  and  trained  for  their 
special  duties,  have  entire  charge  of  certain  subdivisicwns 
of  various  operations.  Closely  related  machines  or  op- 
erations are  merged  into  small,  specialized  departments, 
each,  as  noted  above,  being  under  the  direct  charge  of  a 
single  foreman  or  gang  boss.  In  the  building  operations 
at  the  army  camps,  for  example,  the  practice  in  some 
cases  was  to  let  one  foreman  and  his  gangs  dig  the  holes 
for  the  foundation  posts,  another  set  the  posts,  another 
saw  them  off,  another  lay  the  sills,  and  so  on;  with  such 


3Vorks  Manager 


Men 


Machine  Shop  Sup'i 


Foreman 
Machine 
Tools 


Gang 

Gang 

Boss 

Boss 

Planers 

Lathes 

Men 


DEPARTMENTAL     ORGANIZATION 


q 


Gang 
Boss 
Drill 
Presses 


Men 


] 


a  group  specialization  or  division  of  labor  the  wooden 
structures  of  the  camps  arose  as  if  by  magic.      Each 


198  PRINCIPLES  OF  BUSINES:^ 

foreman,  under  such  an  arrangement,  is  responsible  for 
all  the  operations  included  in  his  department,  and  his 
men  are  not  at  different  stages  of  the  operation  under 
the  charge  of  different  foremen,  as  in  the  purely  func- 
tional organization.  The  departmental  form  of  organi- 
zation may  be  illustrated  by  the  following  chart,  which 
is  the  same  as  that  of  the  ordinary  line  type  except  where 
the  specialization  takes  place  among  the  foremen  and 
gang  bosses. 

Departmentalized  organization  is  seen  to  be  apparently 
an  outgrowth  of  the  line  type — it  may  of  course  include 
also  any  of  the  features  of  the  line-and-staff.  It  resembles 
the  functional  type  to  the  extent  to  which  the  grouping 
in  sub-departments  is  carried  out  with  a  view  to  the  most 
logical  and  comprehensive  assignment  of  functions.  It 
differs  from  functional  organization,  however,  in  that 
the  foreman  and  his  gang  deal  with  functions  in  cross- 
sections,  so  to  speak,  instead  of  with  complete  functions. 
For  example,  in  a  purely  functional  organization  the  re- 
pair boss  is  responsible  for  the  upkeep  of  all  the  ma- 
chinery in  the  establishment,  while  in  the  departmental 
organization  each  foreman  is  required  to  keep  in  repair 
the  machines  in  his  own  sub-department.  A  sufficient 
number  of  sub-departments  is  formed,  so  that  the  fore- 
man of  each  is  able  to  give  the  necessary  attention  to 
detail,  with  as  many  men  in  his  gang  as  he  can  handle 
to  advantage. 

The  "committee"  or  "legislative  management" 
type. — It  will  have  been  been  observed  that  the  line  or- 
ganization represents  the  extreme  in  arbitrary  and  auto- 
cratic control  of  a  business.    The  manager,  competent  or 


MANAGEMENT  199 

incompetent,  makes  arbitrary  decisions  and  issues  or- 
ders in  accordance  with  them,  uninfluenced,  unless  in- 
cidentally, by  the  experience  or  suggestions  of  others, 
either  within  the  organization  or  without. 

In  the  committee  or  legislative  management  type  we 
have  the  extreme  in  democracy — not  that  actual  power  to 
control  is  in  any  manner  surrendered  by  the  manager, 
but  that  help  in  deciding  the  problems  of  the  organization 
is  asked  and  obtained  not  only  from  the  staff  specialists 
but  also  from  subordinate  officials,  or  even  from  the 
workmen  themselves.  This  is  accomplished  by  the  form- 
ing of  committees  upon  which  are  represented  the  various 
departments  and  sub-departments  of  the  organization, 
which  committees  meet  with  and  make  recommendations 
to  the  management. 

Favorable  action  by  the  management  enacts  the  recom- 
mendations into  "laws"  binding  upon  the  line,  i.  e.,  future 
orders  issued  are  to  be  in  accordance  with  the  recom- 
mendations. Such  recommendations  may  cover  the 
whole  field  of  activity  of  the  business — sales,  production, 
wage-rates,  welfare,  improvements  in  the  organization — 
in  fact  nothing  is  too  small  or  too  large  to  be  brought 
to  the  attention  of  the  management  by  these  committees. 
The  members  of  these  committees  are  certain  department 
heads,  together  with  members  elected  by  the  employees 
or  appointed  by  the  management.  Both  line  and  staff 
are  represented^  although  the  committees,  as  such,  belong 
to  the  staff.  Election  or  appointment  to  these  commit- 
tees, so  far  as  representation  of  the  workmen  is  con- 
cerned, is  an  honor  to  be  striven  for,  and  comes  as  a  re- 
ward for  the  taking  of  an  intelligent  interest  in  the  work 


200  PRINCIPLES  OF  BUSINESS 

and  surroundings.  Under  this  system  the  ambitious  em- 
ployee is  brought  to  the  attention  of  the  management. 

The  "suggestion  system." — The  so-called  suggestion 
system — not  a  form  of  organization,  but  which  may  be 
adopted  as  an  adjunct  to  any  type  of  organization — may 
be  noted  in  connection  with  the  legislative  management 
type  which  has  just  been  described.  As  illustrative  of  the 
operation  of  a  suggestion  system,'  the  plan  of  the  East- 
man Kodak  Company  may  be  cited,  as  described  by  Mr. 
Edwin  A.  Hunger,  of  this  company,  in  Factory,  April, 
1918. 

"The  two  major  requisites  of  a  suggestion  system," 
says  Mr.  Hunger,  "are  making  a  main  issue  of  it,  and 
not  a  side  issue,  and  giving  substantial  rewards  for  sug- 
gestions adopted."  The  Eastman  Company's  organization 
for  handling  the  system  consists  of  a  general  chairman,  a 
secretary,  and  five  separate  committees  of  three  depart- 
ment heads  each.  Each  of  these  committees  acts  only 
upon  suggestions  coming  under  one  of  the  following 
classifications  :  cost  reduction ;  improvement  of  product : 
general  maintenance;  accident  prevention;  improvement 
in  factory  methods. 

Employees  below  the  rank  of  foreman  are  encour- 
aged to  send  in  suggestions,  and  for  those  adopted  re- 
wards are  given  according  to  their  value,  or  estimated 
value,  ranging  from  a  minimum  of  from  one  to  five 
dollars  for  suggestions  of  the  respective  classes,  to  an 
indefinite  maximum.  The  largest  awards  so  far  made 
have  been  as  much  as  $1,100. 

While  foremen,  for  reasons  of  policy,  are  not  allowed 
to  compete  under  the  regular  system,  special  "foremen's 


MANAGEMENT  201 

non-participating  prizes"  are  given  to  the  foremen  who 
during  stated  periods  have  sent  in  the  greatest  number 
of  suggestions  which  are  adopted. 

In  order  to  handle  complaints  of  unfairness,  a  special 
"grievance  committee"  meets  at  regular  intervals. 

To  indicate  the  scope  of  the  system — in  19 16  the  East- 
man plant  at  Kodak  Park,  with  4.500  employees,  adopted 
1,000  suggestions,  out  of  2,300  submitted. 

Publicity  and  frequency  of  awards  are  means  of  keep- 
ing up  interest. 

The  most  noticeable  benefits  resulting  from  the  system 
are :  Stimulation  of  employees'  interest  in  their  tasks ; 
Improvement  of  the  company's  products;  Promotion  of 
welfare  work;  Keeping  a  line  on  men  deserving  promo- 
tion and  also,  on  the  other  hand^  on  the  foreman  who 
*'needs  no  help  from  anybody." 

Functional  organization. — The  functional  type  of  or- 
ganization is  that  which  is  identified  with  scientific  man- 
agement. The  basic  idea  in  this  form  of  organization 
is  the  distribution  of  tasks  in  such  a  manner  that  each 
worker  and  each  supervisor  will  have  as  few  distinct 
duties  as  possible.  Under  such  an  arrangement,  duties 
can  be  assigned  to  those  who  are  especially  fitted  to  per- 
form them.  The  worker,  moreover,  by  constant  repeti- 
tion of  the  same  process,  becomes  far  more  proficient 
than  if  he  had  a  number  of  varied  duties.  Practically, 
however,  "functionalization"  affects  principally  the  larger 
or  more  inclusive  functions,  such  as  planning  as  distin- 
guished from  performance,  and  functions  which  are  com- 
mon to  more  than  one  department  or  subdepartment,  such 
as  care  of  belting,  repairing  machinery  and  the  like.    The 


202  PRINCIPLES  OF  BUSINESS 

foremen,  in  a  functional  organization,  are  responsible 
directly  to  the  manager  of  the  department  and  not  to 
over-foremen  or  superintendents.  On  the  other  hand,  the 
foremen  come  directly  in  contact  with  the  men  who  are 
at  work,  without  the  intermediation  of  gang  bosses.  (The 
"gang  boss''  in  the  functional  organization  is  a  foreman 
of  equal  rank  with  the  other  foremen.)  Since  these  fore- 
men are  skilled  and  competent  men,  chosen  especially  for 
their  specific  duties,  the  intimate  association  between  them 
and  the  workmen  is  a  decided  advantage. 

The  most  striking  feature  of  functional  organization 
is  the  complete  separation  of  planning  and  performance. 
Everything  that  is  to  be  done  is  planned  in  detail  before 
performance  begins.  The  men  while  working  at  their 
speciahzed  tasks  are  at  different  stages  of  the  process 
under  different  foremen,  as  will  be  explained  in  the  fol- 
lowing section. 

Functional  organization  in  shop  work. — While  a 
functional  division  of  labor  is  expedient  in  whatever 
department  it  can  be  instituted,  it  is  in  shop  work  that  it 
has  reached  its  highest  development.  The  system  here 
described  was  devised  by  the  late  F.  "W.  Taylor  (1856- 
1915),  whose  studies  with  the  object  of  eliminating 
wasted  effort  in  shop  work  led  to  his  discovery  of  the 
principles  incorporated  in  what  is  known  as  "scientific 
management." 

In  shop  work  under  the  Taylor  system  a  planning  de- 
partment is  maintained  where  all  data  relevant  to  the  plan- 
ning of  the  work  are  kept.  These  data  include  records 
of  the  best  methods  for  performing  every  task,  secured 
by  time-and-motion  study  as  described  in  the  following 


MANAGEMENT 


203 


chapter.  The  planning  department  also  has  all  necessary 
data  pertaining  to  the  work  which  is  under  way,  the 
machines  and  men  available  for  each  task,  and  other  in- 
formation of  a  like  nature.  The  task  is  planned  and 
instructions  are  written  out  covering  each  stage  of  the 
process,  so  that  the  men  and  machines  assigned  to  the 


GENERAJL  MANAGER 


I 


Iworks  Majuger    I 
I 


Koute 
Qerk 

Instruc- 
tion 
Card 
Man 

Gang 
Boss 


Speed 
Boss 


Inspec- 


Timo 
and 
Cost 
Clerk 


Repair 
Boss 


Ditcip- 
Unarian 


FUNCTIONAL   ORGANIZATION 

(Showing  the  eight  "functional  foremen") 

task  are  not  kept  waiting.  The  work  in  the  shop,  instead 
of  being  under  a  single  foreman,  is  supervised  by  eight 
"functional"  foremen,  each  having  a  separate  division  of 
the  labor  of  supervision  and  each  responsible,  as  noted 
above,  directly  to  the  works  manager. 

Receiving  the  order. — When  an  order  comes  in,  one 
that  requires  engineering,  for  example,  the  order  is  first 
submitted  to  the  credit  man  for  approval  or  rejection. 
If  the  applicant's  credit  is  good,  the  engineering  room 
and  the  drafting  room  prepare  the  drawings  and  the  bill 
of  materials.  The  bill  of  materials  or  list  of  supplies 
needed,  with  instructions  for  delivery,  is  sent  to  the 
stores  department,  which  delivers  them  at  the  specified 
place  and  time. 


204  PRINCIPLES  OF  BUSINESS 

The  "route  clerk." — The  "route  clerk,"  or  "order  of 
work  clerk,"  the  first  of  the  functional  foremen,  is  located 
in  the  planning  department.  He  decides  upon  the  order 
of  work  for  the  day  in  the  shop,  and  also  makes  the  in- 
dividual "route  sheets,"  which  specify  the  course  of  an 
order  through  the  shop.  He  is  a  skilled  machinist,  thor- 
oughly familiar  with  all  conditions  in  the  shop,  so  that 
he  is  able  to  take  the  drawings  and  decide  the  best  way 
in  which  the  work  can  be  done  and  also  to  select  the  par- 
ticular machines  and  men  who  are  to  do  it.  The  work- 
men's instructions  as  to  where  they  are  to  be  at  specified 
times  during  the  day  are  hung  on  a  "bulletin  board." 
The  order  is  "routed"  through  the  shop,  the  route  sheet 
showing  the  operations  in  proper  sequence. 

The  "instruction-card  man." — The  "instruction-card 
man"  is  a  specialist  who  studies  the  instructions  on  the 
route  sheet  and  puts  the  detailed  directions  for  each 
operation  on  the  "instruction  card" — a  card  which  goes 
with  the  job,  so  that  the  workman  at  his  task  has  com- 
plete information  as  to  how  each  detail  is  to  be  performed. 
The  instruction-card  man  will  use  "standard" — that  is 
to  say,  previously  perfected — methods  as  far  as  they  are 
applicable,  and  will  devise  the  best  methods  he  can  for 
performing  of  irregular  or  unstandardized  operations. 
Standards  in  this  sense  ma}^  be  methods,  materials  or 
parts  which  have  been  ascertained  by  careful  experiments 
to  be  the  best  for  the  purposes  for  which  they  are  to  be 
used.  When  the  "one  best  way"  is  ascertained  by  time- 
and-motion  study,,  it  is  adopted  as  a  "standard." 

The  "gang  boss." — The  job  then  goes  to  the  "gang 
boss"  in  the  shop.     The  gang  boss  has  previously  been 


MANAGEMENT  205 

informed  of  its  coming  and  has  made  all  preparations, 
such  as  assembling  materials  and  tools,  which  have  been 
delivered  by  the  stores  department.  The  workman  also 
arrives  at  the  indicated  time,  having  been  notified  by 
means  of  a  tag  on  the  bulletin  board.  The  gang  boss 
sees  that  the  job  is  properly  begun  in  accordance'  with  the 
directions  contained  in  the  instruction  card,  and  that  the 
w^orkman  understands  his  instructions  and  is  apparently 
competent  to  carry  them  out  on  schedule  time. 

The  "speed  boss." — The  job  is  next  taken  charge  of 
by  the  "speed  boss,"  who  sees  that  the  operations  are 
performed  according  to  the  instructions  detailed  on  the 
instruction  card.  The  term  "speed  boss"  has  been  an 
unfortunate  one,  misunderstood  or  misinterpreted  by  the 
labor  unions.  "Speed"  refers  not  to  driving  the  work- 
man at  the  highest  possible  speed,  but  merely  to  main- 
taining standard  or  schedule  speed,  which  has  been  de- 
termined as  the  most  economical  that  can  be  maintained 
without  injury  to  machine  or  workman.^ 

The  inspector. — The  operation  under  the  speed  boss 
being  completed,  the  job  is  examined  by  the  inspector, 
whose  duty  it  is  to  see  that  the  instructions  have  been 
complied  with  and  that  there  are  no  defects  of  material. 
Inspection  completed,  the  gang  boss  moves  the  job  to 
another  machine  for  its  next  operation,  or  if  it  has  been 
completed,  sends  it  to  the  assembling  room  or  to  the 
shipping  room. 

The  "time  and  cost  clerk." — The  next  functional 
foreman  is  the  "time  and  cost  clerk,"  who  takes  the  time 

1  The  term  "schedule  boss,"  or  some  similar  term,  ought  to  be 
a-dopted  in  place  of  the  ill-fated  term  now  generally  in  use. 


2o6  PRINCIPLES  OF  BUSINESS 

cards  of  the  men  who  have  worked  on  the  job,  and 
computes  the  wages  and  bonuses  earned  by  the  work- 
men and  turns  in  to  the  cost  department  the  separate 
items  of  cost  that  have  entered  into  the  work. 

The  "repair  boss." — The  "repair  boss"  is  the  func- 
tional foreman  in  charge  of  the  upkeep  of  all  machines 
in  the  establishment. 

The  "disciplinarian." — The  "disciplinarian" — the 
eighth  and  last  of  the  functional  foremen — has  charge  of 
discipline  among  the  men;  he  alone  suspends  or  dis- 
charges them,  and  may  have  the  duty  of  hiring  them  as 
well. 

It  will  be  observed  that  all  the  duties  of  these  eight 
foremen  were  formerly  performed  by  one  "all  round" 
man.  While,  as  Dr.  Taylor  pointed  out,  it  is  practically 
imjjossible  to  get  one  man  competent  to  perform  them 
all,  it  is  not  difficult  to  get  eight  men,  each  of  whom  has 
the  qualifications  which  enable  him  to  perform  to  ad- 
vantage a  single  division  of  the  duties  of  foremanship. 

"Lost  motion"  eliminated. — Despite  the  fact  that  in 
the  functional  organization  there  are  eight  foremen 
employed,  whereas  in  the  military  organization  there 
would  be  only  one  in  each  shop,  there  is  a  very  little 
waste  of  time  or  energy  under  the  functional  system, 
for  nothing  is  done  that  does  not  have  to  be  done  under 
any  other  system.  The  planning  of  the  work,  for  ex- 
ample, is  done  by  competent  men  with  all  necessary  data 
at  their  finger-tips,  whereas  under  the  old  systems  the 
planning  had  to  be  done  in  part  by  the  foremen  and  in 
part  by  the  workmen,  themselves,  while  expensive  ma- 
rines w^ere  standing  idle. 


MANAGEMENT  2oy 

Why  increase  of  output  is  profitable. — Here  it  may 
be  well  to  explain  briefly  why  it  is  so  advantageous  to  a 
factory  to  increase  the  output  of  the  workmen,  and  even 
to  pay  large  bonuses  for  extra  piece-work  or  overtime. 
It  is  because  the  labor  cost,  large  though  it  may  be,  is 
only  a  minor  part  of  the  total  production  cost.  Over- 
head expense  goes  on  continually,  interest  and  deprecia- 
tion mount  up  and  every  extra  piece  of  work  turned  out 
is  practically  clear  gain,  although,  of  course,  the  cost 
is  distributed  over  the  entire  output.^ 

Installation  of  a  functional  system. — Functional  or- 
ganization, identified  with  scientific  management,  must, 
according  to  its  originator,  the  late  F.  W.  Taylor,  be  in- 
stalled in  full  or  not  at  all.  Mr.  Taylor  insisted  upon 
the  complete  scientific  preliminary  research,  the  pains- 
taking time-and-motion  studies,  and  the  complete  rear- 
rangement of  the  system.  In  some  cases,  however,  it 
has  been  found  possible  to  adopt  functional  organization 
in  part,  with  excellent  results.  It  is  only  fair  to  say, 
however,  that  many  incompetent  and  ignorant  men,  po- 
sing as  "efficiency  experts."  have  undertaken  to  install 
their  particular  brands  of  "scientific  management.'"  to  the 
inevitable  disaster  of  the  concerns  employing  them.  Such 
failures  should  not  be  attributed  to  functional  organiza- 
tion or  scientific  management,  but  to  the  inexpertness  of 
the  "expert.'' 

^  The  term  "load-factor"  explains  the  situation.  By  "load-factor" 
is  meant  the  ratio  of  average  use  of  a  planf  to  its  total  possible  use. 
Thus,  if  a  dynanio  has  a  capacity  of  500  kilowatts  and  the  average 
amount  of  electric  current  used  by  consumers  is  300  kilowatts,  the 
load-factor  is  60.  Public-utility  engineers  employ  the  term  con- 
stantly and  aim  in  every  way  to  increase  the  load-factors  of  plants 
under  their  control 


2o8  PRINCIPLES  OF  BUSINESS 

ORGANIZATION   OF   DEPARTMENTS 

The  four  "basic"  departments. — All  organization, 
of  course,  must  be  to  some  extent  "functional" ;  the  term 
"functional  organization"  implies  merely  that  in  this  type 
of  organization  the  functions  are  segregated  more  intelli- 
gently than  in  the  other  forms.  A  functional  division 
of  the  activities  of  any  business  leads  to  the  formation 
of  the  four  "basic"  departments — financial,  production, 
sales  and  accounting.  The  number  of  the  departments 
is,  of  course,  purely  arbitrary,  but  the  creation  of  four 
main  divisions  of  the  functions  is  usually  the  most  con- 
venient and  the  most  logical.  Production,  for  example, 
might  be  held  to  include  selling,  since  production  is  not 
complete  until  the  article  is  in  the  hands  of  the  consumer. 
The  finished  product,  to  one  manufacturer,  is  raw  ma- 
terial from  the  point  of  view  of  another.  Likewise,  it 
would  be  equally  logical  to  hold  that  production  is  in- 
cluded in  selling,  for  an  article  must  be  procured  before 
it  can  be  sold.  The  fact  that  specialized  ability,  however, 
is  required  at  each  successive  stage  of  the  processes  of 
business,  makes  it  advisable  to  segregate  the  activities  of 
the  business  by  creating  a  number  of  departments,  each, 
under  the  charge  of  a  manager  who  has  the  requisite 
special  training  as  well  as  natural  fitness  for  his  position. 

Brief  outlines  of  the  organization  of  the  four  inclusive 
departments  are  given  in  the  pages  following;  the  de- 
partments in  operation  will  be  described  more  fully  in 
separate  chapters. 

The  financial  department. — An  arbitrary  classifica- 
tion of  the  activities  of  the  financial  department  might 
indicate  two  main  divisions  of  the  work  of  this  depart- 


MANAGEMENT 


209 


2IO 


PRINCIPLES  OF  BUSINESS 


■ment:  (i)  financing,  in  its  broader  sense  and  (2)  the 
ordinary  or  routine  collection  and  disbursement  of 
money.  Under  the  first  division  would  come  the  secur- 
ing of  funds  for  the  establishment  of  the  business;  and 
for  its  development,  including  the  providing  of  needed 
equipment  and  of  sufficient  working  capital.  The  second 
division  would  include  what  might  be  called  standardized 
operations — taking  care  of  bills  receivable  and  bills  pay- 
able, "meeting"  the  payroll,  and  the  safe-keeping  of 
actual  money. 

The  chart  given  herewith  indicates  the  organization 
of  a  financial  department.  Important  questions  of  finan- 
cing, of  course,  will  go  to  higher  general  officials,  or 
even  to  the  stockholders,  subject  to  the  limitations  im- 
posed by  the  charter  or  by  the  laws  of  the  State. 


GENERAL  MANAGER 


Credits  and 
CoUections 


I 


Bucjgets 


Works  Manager 


Sales  Manager 


1 


Comptroller 


CashTieceipls  J        Disbursements  I 

OUTLINE   OF    FINANCIAL    DEPARTMENT 

The  production  department. — Showing  the  organiza- 
tion of  the  production  department,  subject,  of  course,  to 
modification  to  suit  individual  conditions,  we  have  the 
chart  shown  on  the  following  page. 

Under  the  works  manager,  as  indicated  by  the  chart 
referred  to,  are  the  shops  and  foundry,  and  also  the 
stores  and  purchasing  departments.  Subject  to  the  au- 
thority of  the  works  manager,  these  latter  departments 


MANAGEMENT 


211 


would  be  in  charge  of  the  balance-of-stores  clerk  and  the 
purchasing  agent,  respectively.  The  authority  of  the 
works  manager  over  purchases  and  stores,  however,  is 
not  absolute,  but  is  merely  an  authority  to  make  requi- 
sitions, as  provided  by  the  scheme  of  organization.  The 
purchasing  agent  is  responsible  to  the  comptroller  for 
the  proper  conduct  of  his  office. 


CEN^RKL  AANAGBR  . 


I 


Works,  Managtr , 


ManiUacturing 


I 


Stor 


Purchasing 


Engineering 

Drafting 

,Bl>nning 


Foundry 
Forge  Shops 
Machine  Shops 


OUTLINE   OF   PRODUCTION    DEPARTMENT 

Under  the  works  manager  will  be  the  superintendents,, 
foremen  and  workmen.  It  will  be  remembered  that  in 
the  Taylor  system  some  of  the  foremen  are  in  the  plan- 
ning department,  responsible,  with  the  rest  of  the  fore- 
men, directly  to  the  works  manager.  Separate  planning 
departments  may  be  maintained  for  the  shop  and  the 
foundry.  The  functional  foremen,  under  the  Taylor 
system,  are  eight  in  number.  It  is  the  practice  in  estab- 
lishments too  small  to  justify  this  number  of  foremen,  to 
arrange  the  working  system  practically  on  the  same  plan, 
but  to  assign  to  a  single  man  the  care  of  several  func- 
tions.    On  the  other  hand,  if  there  is  more  work  than 


212 


PRINCIPLES  OF  BUSINESS 


the  eight  foremen  can  supervise,  several  foremen  may  be 
appointed  to  a  single  function,  with  an  "over-foreman" 
in  charge  of  each  such  group. 

The  sales  department. — The  structure  of  the  sales 
department  is  indicated  by  the  chart  below. 


GENERAL  MANAGER 


I 


I   Itstimates 

j  t^eparation  of  Ads 

I  Selection  of  Mediiimft 


I  Advertising  Manager    I 


Contracts 
FoUow-up 
Analyses  of  Results 


Sales  Manager 

1 

cDept    J 

Sales  Offices                        Traffi 

I 

1    Salesmen        |       | 

1 

1 

\ 

1       Orders    1    1    Routing    1    j  PoUow-up  1 

OUTLINE    OF    SALES    DEPARTMENT 

In  a  business  of  wide  or  national  scope,  district  sales 
offices  may  be  established,  each  covering  perhaps  several 
States.  Various  considerations  will  determine  the  stra- 
tegic location  of  district  headquarters  and  the  territory 
wdiich  shall  be  included  within  a  district.  Special  condi- 
tions aside,  it  is  well  to  lay  out  sales  districts,  as  well  as 
sub-divisions  of  districts,  on  a  basis  of  population  rather 
than  on  a  geographical  basis.  Progressive  sales  mana- 
gers make  use  of  maps  which  show  the  States  or  mar- 
keting districts  of  the  country  on  a  scale  proportionate  to 
population.^ 

Within  these  sales  districts,   "divisions"   are  created, 

each  division  in  charge  of  a  local  sales  manager  whose 

1  The  more  logical  plan,  where  it  could  be  carried  out,  would  be 
to  draw  the  map  to  a  scale  not  merely  of  gross  population,  but  of 
"population"  of  prospective  or  possible  customers.  Very  careful 
market  analyses  would  have  to  be  made,  in  order  to  obtain  approxi- 
mate accuracy  in  such  a  map,  however,  and  frequent  revisions  would 
be  necessary. 


MANAGEMENT  213 

duty  it  is  to  supervise  the  work  of  the  traveling  sales- 
men within  his  division,  the  division  being  subdivided 
into  "territories,"  each  suitable  in  size  to  occupy  the  time 
and  attention  of  a  single  salesman.  The  local  manager 
must  keep  in  the  closest  personal  touch  with  the  salesman, 
and  see  that  the  territory  assigned  to  each  is  neither  too 
large  nor  too  small  and  that  it  is  "developed''  to  its  best 
possibilities.  Since  it  is  obvious  that  the  local  manager 
is  able  to  give  such  intelligent  supervision  to  only  a 
limited  number  of  territories  and  salesmen,  the  size  of 
his  division  is  determined  by  the  extent  of  the  territory 
he  is  able  to  care  for.  If  the  business  in  a  division 
increases  to  such  an  extent  that  the  local  manager  is  no 
longer  able  to  give  the  requisite  personal  attention  to 
the  work  of  each  salesman,  a  new  division  must  be 
created. 

In  the  chart  of  the  sales  department  it  will  be  observed 
that  the  traffic  or  shipping  department  is  shown  as  a 
subsidiary  of  the  sales  department.  It  is  sometimes  held 
that  the  traffic  department  should  be  placed  under  "pro- 
duction." Delivery  of  the  product  is  undoubtedly  a  part 
of  production,  but  it  is  also  a  part  of  sales.  There  are 
probably  fully  as  many  reasons  for  placing  this  depart- 
ment under  sales  as  for  placing  it  elsewhere.  Produc- 
tion itself  should  be  proportionate  to  expected  sales.  The 
sales  manager,  when  he  makes  a  sale,  is  obliged  to  make 
certain  promises  with  respect  to  delivery.  In  order  that 
he  may  know  what  promises  he  may  make  with  safety, 
and  in  order  that  he  may  be  able  to  fulfill  them,  it  is  essen- 
tial that  he  have  authority  over  the  shipping  department, 
at  least  to  the  extent  that  he  may  specify  the  time  of 


214  PRINCIPLES  OF  BUSINESS 

shipment,  routing,  or  any  other  essential  to  dehvery 
according  to  the  agreement  which  his  department  has 
made  with  the  purchaser. 

The  advertising  department  also  would  seem  to  be 
properly  a  part  of  the  sales  department.  The  work  of  the 
advertising  department  is  preparatory  to  selling  and  con- 
sists, on  the  one  hand,  of  analyses  of  markets  and 
methods  of  appeal,  and  selection  of  advertising  "me- 
diums" ;  on  the  other  hand,  of  the  actual  preparation  of 
copy  and  lay-out,  or  of  whatever  form  of  advertisement 
is  to  be  used,  and  placing  it  in  the  mediums  selected, 
whether  the  medium  be  the  columns  of  a  newspaper  or 
magazine,  a  Broadway  sign,  or  an  automobile  on  a  trans- 
continental  tour. 

There  are  reasons  as  well  why  the  sales  department 
should  include  the  credit  department,  although  in  defer- 
ence to  usage  we  have  shown  the  credit  department  as  a 
subsidiary  of  the  financial  department.  The  work  of  the 
credit  department  is  in  reality  a  planning  for  sales — a 
selecting  of  the  customers  to  whom  credit  sales  may  be 
made  with  safety. 

The  accounting  department. — For  such  detail  of  the 
operations  of  the  accounting  department  as  the  scope  of 
this  book  permits,  the  reader  is  referred  to  the  chapters 
on  "Accounting"  and  "Financial  Statements."  The  or- 
ganization of  the  accounting  department  is  indicated  in 
the  cnart    shown  on  the  following  page. 

The  function  of  the  accounting  department  is  to  fur- 
nish records  which  shall  serve  ( i )  to  show  the  condi- 
tion of  the  business  at  any  given  time,  as  to  its  assets 
and  their  condition;  as  to  the  financial  condition  of  the 


MANAGEMENT 


215 


business;  and  as  to  work  in  process  or  contracted  to  be 
done;  (2)  to  show  whether  each  operation  of  the  busi- 
ness has  or  has  not  been  performed  according  to  the 
rules  laid  down,  and  what  each  operation  has  cost;  (3) 


GENERAL  MANACBK 

1 

1 

- 

1 

1 

1           Comj^ronet_ 

1 

1    Auitor  an4  Aa'tt. 

- 

1 

1 

T 

"T 

Works  Accounts    i 

Traveling-J^udlto*-          '     Gciieral  Accounts     I 

1 

Invoice*          J 

OUTLINE    OF    ACCOUNTING     DEPARTMENT 

as  a  basis  from  which  future  operations  may  be  deter- 
mined. 

The  problems  involved  in  organization. — From  the 
foregoing  brief  account  of  the  organization  of  the  basic 
departments,  subject,  of  course,  to  modification  to  suit 
individual  conditions  or  preferences,  together  with  the 
preceding  discussion  of  the  several  types  of  organization, 
it  will  be  noted  that  it  is  comparatively  an  easy  matter 
to  observe  the  principles  of  functionalization  with  respect 
to  the  larger  divisions  of  the  activities,  but  a  very  diffi- 
cult matter  to  observe  them  with  respect  to  the  lesser 
operations.  Particularly  within  the  sales  and  financial 
departments,  the  specialization  of  the  line  type,  known  as 
departmental  organization,  is  often  the  most  practical. 
The  difficulty  in  applying  the  principles  of  functional 
organization  in  full  is  in  that  there  are  many  extra- 
routine  operations,  or  duties,  and  that  the  duties  them- 
selves are  often  widely   scattered,   with   respect   to  the 


2i6  PRINCIPLES  OF  BUSINESS 

times  and  places  at  which  they  must  be  performed.  Con- 
squently,  considerable  discretion  must  be  allowed  the 
officials  and  their  subordinates  by  whom  these  duties  are 
to  be  performed.  Ample  authority  must  be  given  and 
results  rather  than  conformity  to  working  methods  laid 
down  by  the  management  must  be  the  ultimate  aim.  In 
short,  the  conditions  are  usually  most  favorable  for  the 
use  of  the  line  type  of  organization,  with  the  staff  ad- 
juncts, for  in  such  a  form  of  organization  authority 
may  most  easily  be  distributed  and  responsibility  most 
definitely  fixed.  There  is,  of  course,  an  application  of 
the  law  of  diminishing  returns  to  the  problem  of  or- 
ganization. There  is  a  point  at  which  further  perfection 
of  the  organization  as  a  system  ceases  to  be  financially 
profitable ;  at  this  point  the  cost  of  keeping  the  system  in 
operation  becomes  greater  than  the  value  of  the  complex 
system.  If  operations  are  of  frequent  recurrence,  and 
are  susceptible  of  standardization,  scarcely  any  cost  of 
standardizing  them  is  too  great,  but  where  conditions  are 
so  variable  that  each  operation  of  a  given  class  involves 
new  factors,  it  may  be  cheaper  to  leave  the  varying  op- 
erations to  be  determined  at  the  time  by  the  judgment  of 
a  competent  employee. 

On  the  other  hand,  it  cannot  be  too  strongly  urged  that 
all  operations  be  studied  as  carefully  as  possible  and  that 
as  much  knowledge  as  possible  concerning  each  be  ac- 
cumulated and  filed.  It  is  not  permissible  to  do  anything 
in  a  hit-or-miss  fashion  unless  the  operation  is  of  such 
minor  importance  that  a  scientific  study  would  not  be 
justified.  With  a  careful  study  of  ways  and  means, 
functionalization    and    specialization,    with    their    many 


MANAGEMENT  217 

economies,  may  be  found  practicable  to  a  greater  extent 
than  would  have  been  thought  possible. 

It  is  worth  noting  that  while  shop  work  has  to  a  con- 
siderable extent  been  standardized  and  functionalized,  the 
principles  appHed  in  shop  work  have  not  generally  been 
extended  to  the  other  departments.  This  situation  may 
be  explained  by  the  fact  that  the  men  in  the  shop  have  to 
do  with  machines  which  have  little  or  no  latitude  in  the 
manner  of  their  operation,  and  with  materials  which  are 
subject  to  well-defined  laws.  Consequently,  shop  work 
rests,  more  than  any  other  work,  upon  a  fixed  or  deter- 
minable basis.  In  the  other  departments,  however,  the 
conditions  which  make  for  the  most  productive  activity 
are  not  so  well  understood.  These  conditions  can  be 
determined  only  by  means  of  a  study  of  the  human  ele- 
ments of  the  business  as  painstaking  and  thorough  as  the 
studies  of  the  physical  elements  which  have  made  pos- 
sible the  present  degree  of  control  over  machines  and  ma- 
terials. These  human  elements,  obviously,  consist  of  the 
consumers  who  form  the  market,  as  well  as  of  the  person- 
nel of  the  business  proper.  In  the  chapter  following 
something  will  be  said  concerning  the  human  elements 
here  referred  to  and  a  brief  description  will  be  given  of 
the  several  so-called  types  of  management,  as  distin- 
guished from  organization,  with  which  in  these  pages  we 
have  been  chiefly  concerned. 


CHAPTER    XI 

MANAGEMENT 

(Continued) 

THE  EVOLUTION  OF   MANAGEMENT 

Primitive  management. — Primitive,  unsystematized 
management,  all  too  common  today,  is  so  familiar  as  to 
need  no  description,  further  than  the  pointing  out  of  the 
features  in  which  it  differs  most  widely  from  the  higher 
types.  In  this  type  of  management,  there  is  no  dis- 
cernible separation  of  the  functions  of  organization  and 
administration  or,  in  other  words,  of  planning  and  per- 
formance. 

Perhaps  the  most  noticeable  characteristic  of  this  type 
of  management  is  the  lack  of  record-keeping  and  the  con- 
sequent lack  of  knowledge  concerning  the  business.  A 
typical  example  of  a  business  under  this  kind  of  manage- 
ment would  be  the  small  proprietorship,  managed  by  the 
owner,  who  feels  that  he  is  responsible  to  no  one  except 
himself,  and  that  he  can  carry  in  his  head  as  much  knowl- 
edge of  his  business  as  is  necessary.  To  be  sure,  he  will 
keep  accounts  with  his  customers,  of  uncertain  accuracy, 
and  perhaps  a  spindle-file  or  a  desk-drawer  for  the  bills 
that  he  owes,  but  he  will  have  only  a  vague  idea  of  the 
amounts  of  each  class  of  bills,  and  will  be  likely  to  know 
nothing  of  the  actual  financial  condition  of  his  business, 
except  in-so-far  as  he  can  judge  of  it  by  the  size  of  his 
bank  account  or  by  the  general  impression  he  gets  when 

218 


MANAGEMENT  219 

looking  over  his  stock  of  goods  or  other  assets.  Worst 
of  all,  he  is  entirely  without  such  information  as  an 
income  statement  would  reveal.  Despite  all  this,  of 
course,  he  may  be  possessed  of  a  native  shrewdness  which 
enables  him  to  conduct  his  business  quite  successfully, 
especially  when  times  are  ''good;"  but  he  will  rarely  be 
able  to  cope  with  unfavorable  conditions  or  with  the 
competition  of  better-managed  businesses,  both  of  which 
difficulties  are  certain  to  come,  sooner  or  later. 

In  a  business  of  this  kind,  plans  are  made  as  the  work 
goes  along;  the  manager  prides  himself  upon  never  cross- 
ing a  bridge  until  he  comes  to  it,  or,  in  other  words,  upon 
the  fact  that  he  does  not  build  a  bridge  until  he  arrives 
at  the  stream.  Surely  this  is  not  a  policy  to  be  proud  of. 
Judgment,  of  course,  is  arbitrary,  that  is,  not  based  upon 
accurate  knowledge  of  conditions,  but  upon  whim,  preju- 
dice and  guesswork.  Since  there  are  no  records,  experi- 
ence is  a  doubtful  guide.  If  our  manager  asks  and  re- 
ceives advice,  he  will  not  follow  it  unless  it  agrees  with 
what  he  already  had  in  mind. 

Record-keeping  management. — The  first  stage  in  ad- 
vance of  the  type  of  management  noted  above  is  that  in 
which  records  are  kept,  not,  perhaps,  with  any  very  defi- 
nite end  in  view,  but  just  as  a  matter  of  "business."  The 
manager  may  not  make  much  use  of  the  records  except 
to  look  over  them  sometimes  to  refresh  his  memory,  but 
being  of  a  methodical  turn  of  mind  he  likes  to  have  every- 
thing down  in  "black  and  white."  There  seems  to  be  a 
distrust  of  customers  altogether  out  of  perspective  with 
the  owner's  distrust  of  his  own  ability  to  make  his  busi- 
ness  functions  operate   economically. 


220  PRINCIPLES  OF  BUSINESS 

Closely  following  the  mere  keeping  of  records,  is  the 
stage  in  which  the  records  are  assembled  and  balance- 
sheets  are  made  up,  so  that  the  manager  may  know  ex- 
actly "where  he  is  at."  All  too  many  managers  seem  to 
be  incapable  of  going  beyond  this  stage.  They  are  con- 
tent to  exercise  their  otherwise  unaided  judgments  with 
respect  to  whatever  problems  arise,  feeling  that  by  means 
of  the  balance-sheet  they  can  tell  whether  or  not  the  con- 
dition of  the  business  will  w^arrant  additional  expendi- 
tures or  investments.  Thus  the  records  which  they  keep 
are  no  more  than  a  measure  of  the  previous  success  of 
the  business  as  a  whole,  and  an  indication  of  the  extent  to 
w^hich  new  obligations  may  with  safety  be  incurred. 
There  may  also  be  an  effort  to  draw  conclusions  as  to 
which  lines  of  activity  have  been  most  profitable,  as  in- 
dicated by  the  totals  for  the  several  departments.  Such 
conclusions  are,  however,  of  little  value,  since  it  may  be 
assumed  that  costs  have  not  been  correctly  allocated. 
Especially  is  this  likely  to  be  true  of  overhead  costs.^ 

Systematized  management. — If  we  may  define  a 
stage  of  management  far  removed  from  the  foregoing, 
and  yet  far  behind  the  stage  represented  at  this  time  by 
scientific  management,  we  may  choose  the  point  at  which 
records  are  not  only  kept,  but  are  used  as  an  aid  to  judg- 
ment; or,  to  some  extent,  instead  of  judgment.  In  order 
that  this  may  be  done,  a  system  of  record-keeping  is 
adopted  in  which  each  operation  bears  its  proper  burden 
of  expense  and  to  which  its  proportionate  share  of  the 
profit  or  loss  can  accordingly  be  credited  or  charged. 
This,  of  course,   implies  analysis  of  the  records;  and 

^See  the  chapter  on  "Cost  Accounting." 


MANAGEMENT  221 

comparisons  of  the  records,  one  with  another.  Separate 
current  operations  will  be  compared,  in  order  that  those 
which  are  the  most  profitable  can  be  ascertained;  and 
comparisons  also  will  be  made  of  current  records  with 
previous  records,  so  that  curves  can  be  plotted  which, 
showing,  as  they  do,  the  upward  or  downward  tendencies 
under  given  conditions,  are  prophetic  as  to  the  outcome  of 
future  operations  of  the  same  kind. 

At  this  stage  the  manager's  personal  judgment  will  be 
aided  by  the  records  so  interpreted,  and  also  by  available 
records  of  other  businesses.  Market  analyses  will  be 
made  and  business  conditions  in  general  taken  account  of. 

Since  the  business  where  such  an  improved  and  seem- 
ingly adequate  system  might  be  found  would  probably 
be  a  "progressive  "  one,  if  not  already  large,  the  manager 
would  find  that  his  own  judgment,  even  aided  by  the 
records,  was  inadequate,  at  times  when  decisions  were  to 
be  made  upon  questions  where  special  knowledge  was  re- 
quired. Accordingly  he  would  add  expert  engineers  or 
other  specialists  to  his  organization,  their  duty  being  to 
make  investigations  and  reports  or  recommendations  upon 
matters  within  their  respective  provinces.  In  this  way 
the  so-called  line-and-staff  organization  comes  into  exist- 
ence, the  '"line"  being  composed  of  executive  officials  and 
their  subordinates,  and  the  "staff''  of  advisory  officials. 
Recommendations  being  made  by  the  staff,  they  would  be 
considered  and  probably  adopted  by  the  management, 
and  made  binding  upon  the  line  for  their  carrying  out. 

It  will  be  noted  that  at  this  stage  of  management  the 
correctness  of  the  methods  evolved  by  skilled  workmen  is 
taken  for  granted.     Operations  may  be  analyzed  to  the 


222  PRINCIPLES  OF  BUSINESS 

point  of  recording  separately  the  total  of  each  workman's 
part  in  the  operation,  but  analysis  goes  no  further  than 
this.  Totals  are  arrived  at  by  adding  together  the  sub- 
totals, without  ascertaining  whether  or  not  the  items 
composing  the  sub-totals  are  correct. 

It  is  not  to  be  inferred  from  this,  however,  that  the  in- 
completeness of  the  records,  with  respect  to  their  detail 
below  a  certain  point,  is  something  that  could  easily  be 
remedied — something  that  denotes  a  carelessness  on  the 
part  of  the  management,  or  a  failure  to  realize  the  desir- 
ability of  having  the  records  fundamentally  conclusive. 
Ideal  records  are  obtainable  only  by  means  of  the  methods 
of  scientific  management,  described  hereafter,  and  there 
has  not  yet  been  time  for  scientific  management  to  become 
generally  adopted ;  because,  on  the  one  hand,  of  the  actual 
cost  of  the  installation,  which  may  easily  be  as  high  as 
$25,000  or  $50,000,  involving  also  several  years  of  dis- 
turbance before  its  benefits  are  felt;  and,  on  the  other 
hand,  because  of  the  vigorous  opposition  of  the  labor 
unions,  which  foresee  in  scientific  management  a  menace 
to  their  desired  control  of  the  accumulated  knowledge  of 
the  processes  of  industry. 

Systematized  management,  therefore,  is  the  type  most 
commonly  found  in  the  larger  and  better  businesses  of 
today. 

Since  the  collecting  and  interpreting  of  all  kinds  of 
data  which  have  or  might  have  a  significance  with  respect 
to  the  future  of  the  business  is  the  chief  duty  of  manage- 
ment, and  since  the  most  important  of  such  data  are  in 
the  form  of  reports  of  the  various  departments,  we  may 
give  here  an  excellent  compilation  of  the  rules  for  good 


MANAGEMENT  223 

reports,  together  with  the  detailed  contents  of  such  re- 
ports, taken  from  System,  May,  191 8. 

Rules  for  good  reports. — i.  Reports  should  furnish 
a  complete  picture  of  what  the  manager  should  know. 

2.  Reports  should  be  concrete  and  self-explanatory. 

3.  Reports  should  show  whether  the  business  is  going 
ahead  or  backward,  not  only  as  a  whole  but  by  depart- 
ments, and  should  show  not  only  immediate  profits,  but 
should  indicate  the  state  of  health  of  the  business  in 
general. 

Contents  of  reports. — "The  reports  should  inform 
the  manager  as  to : 

1.  Running  inventory  of  stock  (by  stock;  by  selling 
price;  by  quantities;  purchases;  used  or  sold;  balance  on 
hand — by  departments  and  by  lines;  by  percentage  of 
sales  ) . 

2.  Sales  (total ;  by  departments  ;  charge ;  cash,  by  lines ; 
by  salesman;  by  territories;  by  percentage  to  total;  by 
new  business). 

3.  Profits  or  losses  (by  departments;  by  Hues;  by  sales- 
man; by  territories;  by  percentages;  by  discounts  taken). 

4.  Cost  of  doing  business  (total;  by  departments;  by 
kinds  of  expense;  in  dollars  and  cents;  in  percentage  of 
sales  or  costs). 

5.  Collections  (total;  percentage  of  sales;  by  territo- 
ries). 

6.  Outstanding  obligations  (total;  by  percentage  of 
sales;  by  territories;  overdue). 

7.  Goods  returned  (total;  by  lines;  by  territories;  by 
percentage  of  sales). 

,     8.  Balance  sheet  (assets;  Habilities). 


224  PRINCIPLES  OF  BUSINESS 

g.  Financial  statement  (periodical  summary  of  opera- 
tions). 

10.  Trade  and  business  conditions  (crops;  money 
market;  new  inventions;  development  in  trade  customs; 
styles;  transportation;  weather  conditions). 

11.  Efficiency  of  employees  (by  profits;  by  depart- 
ments; percentages  on  standards  of  work  and  conduct; 
and  complaints). 

12.  Advertising  (total;  by  departments;  by  mediums; 
by  results). 

13.  Cash  (receipts;  disbursements;  anticipated  pay- 
ments). 

14.  Rates  of  turnover  (on  total  business;  by  depart- 
ments, by  lines;  day's  sales  on  ledger). 

15.  Production  (by  amount  finished;  under  way;  not 
started;  time  lost;  by  total  cost;  by  unit  cost;  by  labor 
cost,  direct  and  indirect;  by  material  cost;  by  overhead). 

16.  Mark-ups  and  mark-downs  (total;  by  departments; 
by  percentages)." 

All  such  reports  should  be  made  on  standardized  re- 
port forms  or  "blanks,"  so  that  the  manager  may  be  sure 
that  each  caption  in  successive  reports  includes  the  same 
data.  This  is  necessary  not  only  in  order  to  save  time, 
but  for  the  sake  of  accurate  comparison  of  records  for 
succession  or  corresponding  periods.  When  such  a  com- 
parison shows  an  unfavorable  condition  the  manager 
may  take  such  measures  as  may  be  necessary  to  provide 
a  remedy. 

SCIENTIFIC    MANAGEMENT 

The  Taylor  System. — The  latest  stage  in  the  evolu- 
tion of  management  is  represented  by  the  Taylor  system, 


MANAGEMENT  225 

also  known  as  scientific  management.^  In  this  system  not 
only  is  interpretation  of  records  substituted,  so  far  as  may 
be  possible,  for  unenlightened  judgment,  but  the  records 
themselves  represent  performance  in  harmony  with  fun- 
damental principles.  The  testimony  of  the  records,  ac- 
cordingly, becomes  incontrovertible,  and  the  decisions  of 
the  manager,  like  those  of  an  upright  judge,  are  deter- 
mined by  the  law  and  the  evidence. 

In  order  that  performance  may  be  in  accordance  with 
fundamental  principles,  each  operation  is  taken  apart,  so 
to  speak,  and  studied  in  detail,  and  built  up  again  in  the 
"one  best  way."  Incidentally,  it  was  observed  by  Mr. 
Taylor  that  in  order  that  a  task  may  be  performed  in  the 
best  possible  way,  it  is  necessary  to  plan  it  in  detail  before 
actual  performance  begins;  thus  it  is  a  feature  of  scien- 
tific management  that  planning  and  doing  be  regarded  as 
separate  functions. 

In  our  approach,  then,  to  the  brief  consideration  of 
scientific  management  v/hich  follows,  it  will  be  remem- 
bered that  the  essential  principle  of  this  system  is  that 
the  "one  best  way"  must  be  sought  for  through  ex- 
perimentation of  laboratory  exhaustiveness  and  scientific 
accuracy. 

What  is  meant  by  the  term  "scientific  manage- 
ment."— The  term  "scientific  management"  is  to  be  used 
only  to  designate  any  type  of  management  in  which  are 
not   only   incorporated,    but   actually   applied,    the   prin- 

^  To  Dr.  Taylor  belongs  the  credit  of  the  practical  working  out  of 
scientific  management  methods,  although  methods  somewhat  similar 
to  those  of  the  Taylor  System  were  introduced  independently  by 
other  managers,  both   in  the  United   States  and  in  France. 


2j6  principles  of  BUSINESS 

ciples  of  management  formulated  by  the  late  F.  W. 
Taylor/ 

The  fact  that  a  manager  attempts  to  be  scientific  in 
his  methods  does  not  constitute  his  system  a  scientific 
management  system,  for  the  scientific  spirit  alone  is  not 
sufficient.  The  road  to  bankruptcy  is  paved  with  good 
intentions. 

The  preliminary  stages  of  scientific  management. 
— If  an  industrial  engineer  were  called  upon  to  install  a 
system  of  scientific  management  in  an  establishment, 
the  first  thing  he  would  do  would  be  to  make  a  thorough- 
going study  of  the  business — as  a  whole,  and  also  in 
detail.  From  an  analysis  of  the  needs  and  purposes  of 
the  business,  he  would  plan  a  reorganization  of  its  parts 
in  their  relation  one  to  another.  The  new  organization 
would  provide  as  far  as  possible  for  a  functional  divi- 
sion of  labor,  including  a  functional  management  of 
labor.^ 

Since  it  is  fairly  well  known  what  operations  can  be 
performed  by  machines,  with  a  minimum  of  human 
supervision  or  labor,  the  most  suitable  machines,  if  not 
already  in  use,  would  be  provided  for,  and  the  situs 
of  each  would  be  determined.  These  preliminary  studies 
or  plans  being  made,  the  problem  to  be  solved  would 
be  the  grouping  of  all  the  human  or  labor  functions  into 
duties  or  "tasks,"  and  the  providing  for  the  doing  of  each 
task  in  the  "one  best  way." 

1  While  the  methods  of  scientific  management  had  their  begin- 
nings about  1890,  the  recognition  of  scientific  management  as  a  dis- 
tinct type  did  not  come  until  the  time  of  the  Railroad  Rate  Hear- 
ings in  1910.  At  this  time  a  committee  of  managers  selected  the 
term  "scientific  management"  to  designate  the  "system." 

2  See   "Functional   organization,"   p.   201. 


MANAGEMENT  227 

The  "one  best  way." — In  order  that  an  operation 
may  be  performed  in  the  one  best  way  the  following 
conditions  are  necessary,  substantially  as  set  forth  by 
Dr.  Taylor: 

1.  Standardization  of  the  operation,  including  that 
of  the  machines  and  tools  used. 

2.  The  fitness  of  the  workman. 

3.  A  spirit  of  co-operation  on  the  part  of  the  work- 
man. 

Of  these  three  conditions,  it  is  difficult  to  say  which 
is  the  most  important,  or  which  is  the  first.  All  are 
essential,  although  the  control  of  the  human  element 
is  perhaps  uppermost  in  the  mind  of  the  manager,  since 
the  standardization  of  the  operation,  resulting  in  a 
standard  task,  is  a  problem  solved  once  and  for  all,  ex- 
cept where  the  invention  of  improved  machinery  or  the 
discovery  of  improved  methods  leads  to  a  readjustment. 
The  control  of  the  human  element,  however,  is  a  prob- 
lem that  requires  constant  attention,  and  is  probably  the 
chief  problem  of  management.  We  may  consider  the 
means  of  securing  the  above-named  three  conditions,  tak- 
ing them  one  by  one  in  the  order  in  which  they  are  men- 
tioned. 

Standardization  of  the  operation,  or  formulation 
of  the  "standard  task." — Contrary  to  the  pardonable 
contention  of  the  workman,  it  is  impossible  for  the 
workman  himself,  or  for  generations  of  workmen,  to 
hit  upon  or  develop  the  best  methods  of  performing  their 
work. 

In  the  first  place,  the  doing  of  any  given  task  by  any 
given  workman  must  be  co-ordinated  with  the  doing  of 


228  PRINCIPLES  OF  BUSINESS 

other  tasks  by  other  workmen ;  and  this  is  a  manage- 
ment function,  over  which  the  workman  has  no  control. 

In  the  second  place,  any  operation  consists  of  a  num- 
ber of  separate,  although  related,  component  elements. 
The  most  efficient  combination  of  these  elements  or  move- 
ments can  be  determined  only  by  means  of  experimenta- 
tion under  laboratory  conditions.  Here  also  the  work- 
man has  neither  the  equipment  nor  the  special  training 
which  are  necessary  for  the  discovery  of  the  most  ef- 
fective combinations.  These  considerations  alone  are 
sufficient  to  indicate  that  it  is  out  of  the  question,  from 
the  standpoint  of  efficiency,  for  the  workman  to  insist 
with  any  reasonableness  upon  the  use  of  his  own  tradi- 
tional methods. 

Time-and-motion  study. — "Time-and-motion  study" 
is  the  principal  means  whereby  the  standard  task  is 
evolved ;  and  implies,  along  with  the  study,  the  construc- 
tion, or  synthesis,  of  the  task. 

First,  the  operation  to  be  performed  is  anaI}Ked  or 
resolved  into  its  separate  elements.  When  the  operation 
is  thus  "taken  apart"  it  is  studied  and  timed  in  detail, 
with  the  aid  of  a  stop-watch.  Other  devices  also  may 
be  used,  such  as  an  adaptation  of  the  camera  with  a 
stereoscopic  lens,  and  of  the  moving-picture  camera. 
Each  movement  or  element  in  the  operation  is  studied  as 
a  separate  unit.  After  all  possible  variations  have  been 
tried  and  timed,  the  one  is  selected  which  takes  the  least 
time  or  the  least  exertion.  The  relation  of  each  move- 
ment to  the  preceding  and  following  movements  is,  of 
course,  taken  account  of.  Every  waste  movement  or 
element  is  eliminated  and  the  most  efficient  ones  are  re- 


MANAGEMENT  22g 

tained.  These  retained  elements  are  preserved  and  filed 
as  ''unit  times."  When  the  complete  operation  is  built 
up  of  these  individual  best  elements,  it  is  known  beyond 
question  that  the  operation  represents  the  "one  best  way," 
with  respect  to  that  particular  operation,  wherever  or 
whenever  it  may  be  found,  and  it  is  fixed  in  the  system  as 
a  "standard  task." 

The  standard  task,  of  course,  is  constructed  with  the 
ascertained  best  speed  of  performance,  including  rest- 
intervals,  so  that  it  may  be  performed  consistently  by  a 
fit  workman  without  detriment  to  his  health,  and  with- 
out undue  discomfort.  This  phase  of  the  task  is  con- 
sidered at  some  length  under  "fatigue."  (See  "The 
Control  of  Labor.") 

It  is  assumed  in  the  foregoing  description  of  time-and- 
motion  study,  that  the  tools  or  machines  used  in  the 
course  of  the  study  are  those  which  have  been  proved, 
by  scientific  experimentation,  to  be  the  best  for  the 
purpose  in  view.  The  best  tools,  of  course,  may  be 
selected  by  a  similar  method  of  experimentation.  A 
famous  example  is  the  best-size-of-shovel  study  made  by 
Dr.  Taylor  himself. 

Taking  a  gang  of  average  workmen,  a  number  of  sets 
of  shovels  were  provided,  the  smallest  shovels  holding 
less  than  20  pounds  and  the  largest  more  than  30  pounds. 
It  was  found  that  there  was  a  remarkable  variation  in 
the  amount  of  material  moved  with  shovels  of  different 
sizes.  The  workmen  were  given  first  the  set  of  largest 
shovels.  After  a  time  sufficient  to  establish  conclusive 
results,  the  next  smaller  set  was  substituted,  and  so  on 
until  all  had  been  tried.     The  amount  of  work  done  in- 


230  PRINCIPLES  OF  BUSINESS 

creased  steadily  until  the  21 -pound  shovels  were  used, 
after  which  time  it  decreased  as  consistently.  It  is 
known,  therefore,  that  whatever  be  the  material  to  be 
moved,  a  shovel  holding  about  21  pounds  is  the  size 
which  should  be  provided  for  the  workman.  Since  some 
materials  are  lighter  than  others,  the  capacity  of  each 
size  of  shovel,  with  respect  to  the  various  classes  of  ma- 
terial, must  be  readily  ascertainable. 

It  may  be  noted  how  many  factors  must  be  considered 
even  in  such  a  comparatively  simple  kind  of  work  as 
shovelling.  The  height  of  the  lift,  the  distance  the 
material  must  be  moved,  the  length  and  shape  of  the 
handle,  the  shape  of  the  shovel,  the  position  in  which 
it  is  held,  the  velocity  and  course  of  the  arm  movement, 
the  posture  of  the  body — these  are  only  a  few  of  the  more 
obvious  considerations. 

Prior  to  the  development  of  scientific  management 
such  elements  as  these  received  little,  if  any,  considera- 
tion. The  practical  value  of  correct  posture  and  move- 
ment, however,  have  long  been  recognized  on  the  athletic 
field. 

Another  interesting  illustration  of  the  results  obtain- 
able through  time-and-motion  study,  which  serves  also  to 
indicate  the  imposssibility  of  the  finding  out  of  the  best 
methods  by  the  workmen  themselves,  is  the  series  of  ex- 
periments made  by  Dr.  Taylor  in  the  cutting  of  metals. 
Beginning  the  work  with  the  expectation  of  completing 
it  in  six  months,  he  finished  it  in  twenty-six  years,  at  a 
cost  of  $200,000;  but  in  the  course  of  the  experiments 
(which  were  made  in  collaboration  with  Maunsel  White) 
high-speed  steel  was  discovered  which,  in  normal  times, 


MANAGEMENT  231 

is  estimated  to  have  been  worth  many  hundreds  of 
millions  of  dollars  to  the  industry.  The  value  of  the 
Taylor-White  process  for  war  purposes  may  perhaps 
be  calculated  in  billions.  In  these  experiments,  in  which 
800,000  pounds  of  metal  was  used,  the  problem  involved 
not  only  the  speed,  the  feed,  and  the  depth  of  the  cut; 
but  also  the  design  of  the  cutting  tools  and  the  material 
of  which  they  should  be  made;  and  the  development  as 
well  of  a  steel  which  could  be  cut  most  rapidly  without 
the  sacrifice  of  desired  service  qualities. 

Preservation  and  use  of  knowledge  gained  by  time- 
and-motion  study. — Obviously,  when  by  means  of  time- 
and-motion  study  have  been  discovered  the  best  methods 
of  performing  each  operation,  this  knowledge  must  be 
preserved  and  used. 

The  elemental  unit-times  and  unit-motions,  and  the 
tasks  into  which  thpy  have  been  correlated,  are,  in  reality, 
wares  which  must  be  stored  and  distributed  as  they  are 
needed.  The  preservation  of  these  records  and  the  adopt- 
ing* of  them  as  models  for  future  operations  is  called 
standardization. 

How,  in  actual  practice,  may  the  standards  be  applied? 
The  workmen  could  not  carry  them  all  in  mind,  and, 
besides,  the  workmen  are  always  coming  and  going. 
The  standards,  therefore,  must  be  kept  in  a  place  of 
their  own,  which  is  called  the  planning  department.  Here 
the  standard  instructions  are  kept  on  file,  and  when  any 
work  is  to  be  done  the  standards  pertaining  thereto  are 
made  the  basis  of  an  "instruction  card,"  showing  in  de- 
tail all  that  is  to  be  done.  This  card  is  sent  to  the  work- 
man   for  his   guidance;   personal   assistance,   where   re- 


232  PRINCIPLES  OF  BUSINESS 

quired,  is  given  by  a  foreman  in  the  shop.  Another 
foreman  supervises  the  work  as  it  progresses,  another  in- 
spects it,  and  still  another  checks  it  up  and  calculates  the 
cost. 

Not  only  do  the  standards  serve  as  models  for  like 
operations,  but  when  a  new  task  is  to  be  constructed 
many  elements  of  the  new  task  can  be  taken  directly  from 
the  file  of  unit  times  and  movements,  obviating  to  that 
extent  the  need  of  a  new  time-and-motion  study  for  each 
new  task.  This  may  need  no  further  explanation,  but 
for  the  sake  of  an  apt  comparison,  the  unit  times  and 
movements  kept  on  file  are  like  a  set  of  building-blocks, 
of  which  a  variety  of  houses  may  be  built. 

As  to  the  division  of  labor,  in  the  distribution  of  tasks, 
reference  may  be  made  to  "Functional  Organization,"  in 
the  preceding  chapter. 

It  will  be  noted  that  the  concentration  of  the  work  of 
planning  in  a  separate  department,  while  it  might  seem 
to  increase  the  amount  of  "indirect  labor,"  causes  only 
an  increase  in  the  number  of  "indirect  laborers,"  wHich 
is  not  at  ali  the  same  thing.  If  the  work  were  nat  done 
by  the  clerks  in  the  planning  department,  some  kind  of 
planning  would  have  to  be  done  by  the  foremen  and  the 
workmen  in  the  shops,  under  conditions  far  less  favor- 
able in  every  respect,  at  the  expense  of  the  time  of  the 
machines,  which  would  be  idle  meanwhile,  and  at  the 
loss  of  the  workman's  time,  taken  from  "productive  la- 
bor," while  he  stopped  from  time  to  time  to  make  his 
plans. 

A  further  application  of  time-and-motion  study,  is  in 
the  handling  of  stores  and  supplies,  including  tools,  re- 


MANAGEMENT  233 

suiting  in  their  delivery  at  the  time  and  place  where  they 
are  needed.  Standardization  here  involves  a  classifica- 
tion, with  symbols  for  each  item,  and  a  standard  method 
of  handling  and  distribution. 

Standardization. — Standardization  means  simply  find- 
ing the  best  for  the  purpose  desired  and  keeping  it  until 
we  get  something  better.  The  principle  of  standardiza- 
tion, if  it  may  be  called  a  principle,  is  perhaps  the  most 
important  business  discovery  of  the  century.  Its  effects 
are  only  beginning  to  be  felt  outside  of  individual  busi- 
nesses, but  the  signs  of  the  times  indicate  that  before 
long  we  shall  have  interbusiness  as  well  as  intrabusiness 
standardization. 

Standardization  takes,  practically,  two  forms :  ( i )  of 
materials,   (2)  of  methods. 

A  manufacturer  of  automobiles,  for  example,  having 
determined  upon,  or  standardized,  his  policy  as  to  the 
grade  of  car  he  will  build,  and  the  class  of  buyers  he 
will  appeal  to,  must  then  determine  and  adopt  as  "stand- 
ard" in  his  own  business  the  qualities  or  grades  of  ma- 
terial which  he  will  use  in  each  part  of  the  car  in  order 
that  cars  of  uniform  quality  can  be  turned  out  profitably 
at  the  price  at  which  he  has  decided  to  sell  them.  Every 
piece  of  wood  or  steel  must  be  tested  and  found  to  con- 
form to  the  specifications ;  the  finished  car  is  tested  and 
must  develop  as  much  power  and  run  as  smoothly  as 
the  standard  requires. 

,  Just  as  materials  must  be  tested,  so  must  methods  be 
tested  in  order  to  find  which  is  the  best.  Scientific  man- 
agement has  discovered  means,  described  above  and 
known  as  time-and-motion  study,   of  constructing  best 


234  PRINCIPLES  OF  BUSINESS 

methods  by  resolving  an  operation  into  its  original  ele- 
ments and  building  it  up  again  piece  by  piece,  retaining 
only  the  most  economical  elements.  An  operation  so 
constructed  is  adopted  as  "standard."  The  manufac- 
turer, accordingly,  builds  his  standard  car  out  of  standard 
materials  put  together  by  a  standard  sequence  of  standard 
individual  operations. 

The  secret  of  the  success  of  a  very  well-known  manu- 
facturer of  low-priced,  serviceable  cars  lies  in  the  fact 
that  he  has  adopted  in  toto  the  principle  of  standardiza- 
tion. Not  only  does  standardization  lower  his  manu- 
facturing costs,  but  it  enables  users  of  his  cars  any- 
where in  the  world  to  buy  a  new  bearing  or  a  connecting 
rod,  or  for  that  matter  a  new  engine,  for  a  very  few 
dollars  at  the  nearest  hardware  store,  with  the  certainty 
that  it  will  fit.  Standardization  under  scientific  manage- 
ment has  given  this  manufacturer  one  of  the  largest 
incomes,  it  is  said,  which  any  man  has  ever  enjoyed. 

It  is  interesting  to  look  forward  to  some  of  the  possi- 
bilities of  standardization  in  the  business  life  as  well  as 
in  the  social  life  of  the  future. 

The  first  thing  that  impresses  us  is  that  standardization 
presupposes  an  organization  and  a  primary — that  is,  a 
centralized — authority,  by  which  authority  any  proposed 
change  in  the  standards  must  be  approved  and  accepted 
before  it  may  be  adopted.  We  have  seen  that  a  business 
organization  is  created  under  what  we  may  call  the 
"primary  authority"  in  the  organization,  which  primary 
authority  is  the  result  of  the  pooling  of  the  original  au- 
thorities, and  the  placing  of  them  in  the  hands  of  the 
administrator  or  manager  of  a  business. 


MANAGEMENT  235 

The  laws  of  the  nation  are  no  more  than  standardized 
social  customs,  codified  by  the  primary  authority  which 
we  call  the  government.  No  new  law  can  be  added  to 
the  code  until  it  has  been  enacted  and  incorporated  in  the 
standards  by  the  proper  authority,  no  matter  how  ob- 
vious the  improvement  may  be.  It  is  needless  to  enu- 
merate the  advantages  of  having  a  set  of  laws  to 
guide  our  conduct.  We  do  not  feel  that  laws  hamper 
our  individual  progress  and  aspirations.  Without  a  cen- 
tralized authority,  however,  there  could  be  no  laws,  and 
our  best  customs  could  not  be  standardized  and  perpet- 
uated. As  it  is,  we  are  able  to  hold  what  we  have  gained, 
until  the  standards  again  can  be  raised.  What  is  a  good 
law  for  one  generation  may  be  a  bad  one  for  the  next, 
because  with  the  aid  of  the  obsolete  standard  a  new  one 
has  been  made  possible.  We  have  adopted  the  principle 
of  "progressive  standardization"  in  our  government. 

Standardization  as  a  national  habit. — It  is  possible, 
however,  for  standardization  of  material  and  processes 
to  become  a  national  habit.  Just  as  thrift  is  the  habit  of 
the  Scotchman,  and  profligacy  is  the  habit  of  other  peo- 
ples, a  passion  for  standardization  may  well  become  the 
national  habit  of  Americans.  Such  a  desideratum  can 
come  about  only  through  a  long  and  gradual  process  of 
education  in  which  one  profession  after  another  will  be- 
come a  participant.  At  the  outset  the  way  may  well  be 
blazed  by  the  engineer,  to  be  followed  by  the  lawyer,  the 
accountant,  and  the  executive  himself. 

Just  what  this  would  mean  and  how  it  would  come 
about,  is  indicated  in  a  publication  of  the  American  Ex- 
change National  Bank  of  New  York  City.    "Popular  con- 


236  PRINCIPLES  OF  BUSINESS 

sent  to  eliminate  waste  through  standardization  is  _  es- 
sential, however,  and  it  is  just  as  necessary  that  the  aver- 
age man  be  made  to  understand  the  advantages  of  elimi- 
nating waste  in  this  way  as  it  is  that  he  have  the  habit 
of  saving.  Objectors  to  standardization  usually  appeal 
to  the  prejudices  of  the  average  man;  he  is  told,  for  ex- 
ample, that  under  standardization  the  women  would  all 
wear  hats  of  the  same  design  and  coloring;  that  all  cloth- 
ing would  be  cut  to  a  uniform  pattern  and  that  in  a  short 
time  we  would  all  be  living  a  routine  existence,  moving 
about  in  regimented  masses  and  to  the  best  of  time  clocks. 
The  term  standardization,  as  it  is  applied  in  practice,  has 
no  such  significance  as  that;  in  practise  its  significance  is 
largely  what  the  word  implies — dimensional. 

"The  engineer  who  refers  to  standardization — and  it  is 
the  engineer  who  is  the  principal  advocate  of  the  thing 
called  standardization — is  thinking  of  a  pipe  or  a  bolt  on 
which  the  threads  conform  to  a  fixed  standard,  thus  elimi- 
nating the  necessity  for  carrying  large  stocks  of  pipes  and 
bolts  whose  only  difference  is  in  the  width  or  direction  of 
the  thread.  The  manufacture  of  mattresses  is  an  advo- 
cate of  standardization  in  bed  sizes,  because  the  limita- 
tion of  beds  to  standard  sizes  allows  him  to  reduce  the 
number  of  sizes  he  must  carry  in  his  stock  of  mattresses. 
The  same  principle  runs  through  all  industry,  and  such 
simple  and  necessary  standardization  as  here  outlined,  if 
generally  followed,  would,  perhaps,  annually  release  as 
much  capital  for  employment  in  other  fields  as  goes  into 
the  savings  banks  each  year." 

Not  long  ago,  one-price  stores  were  unheard  of.  Not 
much  later,  they  were  a  novelty.     Today  the  term  "one- 


MANAGEMENT  237 

price  store"  is  almost  obsolete,  the  advertising  value  of 
the  sign  "One-Price  Store"  has  disappeared,  because 
all  reputable  stores  now  are  one-price  stores.  The  public 
had  grown  tired  of  the  useless  labor  of  bargaining  over 
individual  purchases. 

Is  the  public  in  these  days  not  growing  tired  of  won- 
dering which  store  is  the  best,  which  automobile  is  the 
best,  which  typewriter  or  sewing-machine  or  phonograph 
is  the  best?  Are  we  not  getting  ready  for  standarciiza- 
tion — with  the  best  goods,  of  whatever  class,  to  be  had 
anywhere  at  a  uniform  price?  Should  we  not  like  to  own 
an  automobile,  or  a  harvester,  or  a  typewriter,  that  com- 
bined the  best  cjualities  of  all,  and  was  made  by  any  com- 
pany that  cared  to  make  it,  but,  engaging  in  its  manu- 
facture, was  compelled  to  make  it  according  to  the  stand- 
ards, so  that  repairs  could  be  had  anywhere  and  men 
skilled  in  operating  or  repairing  it  could  be  found  any- 
where; so  that  we  should  be  saved  the  waste  labor  of 
worrying  over  quality  and  price?  For  that  matter,  it 
would  not  be  necessary  to  provide  against  the  making 
of  unstandardized  staple  articles ;  they  could  not  survive 
in  competition  with  the  others. 

Would  such  a  standardization  tend  to  bring  human 
existence  to  a  "dead  level" — flat  and  uninteresting?  He 
who  imagines  that  has  not  stopped  to  consider  the  in- 
exhaustible richness  of  the  human  mind.  In  the  ascent 
through  civilization  the  highest  peak  has  not  been  reached 
— probably  never  will  be  reached,  for  it  may  be  that  there 
is  no  highest — that  the  scale  is  infinite. 

Progressive  standardization  means  only  that  we  say : 
"This  much  has  been  accomplished.     Let  us  not  spend 


238  PRINCIPLES  OF  BUSINESS 

our  time  in  solving  the  same  problem  again;  leave  it  in 
plain  figures,  on  instruction  cards  and  tables  of  specifica- 
tions, for  the  guidance  of  those  who  do  the  routine 
v^ork,  and  we  shall  have  more  time  to  spend  on  problems 
yet  to  be  solved." 

What  is  advocated  here,  then,  is  standardization  of  the 
accomplished.  Instead  of  lending  itself  to  senseless  varia- 
tions of  the  necessaries  of  life,  creative  imagination  will 
dev||te  itself  to  satisfying  new  demands.  Healthy  compe- 
tition will  develop  variations  in  these  new  supplies  until 
the  one  best  product  or  the  one  best  way  is  found.  An 
intelligent  public  will  then  automatically  standardize  that 
one  best  product  or  method  by  demanding  it  to  the  exclu- 
sion of  others  and  productive  effort  will  then  be  released 
for  new  fields. 

Fitness  of  the  workman. — The  second  of  the  con- 
ditions which  we  have  noted  as  being  requisite  for  per- 
formance in  the  one  best  way,  is  that  the  workman  shall 
fit  the  task,  the  task  itself  having  been  devised  so  that 
it  will  fit  the  special  kind  of  workman  who  is  to  per- 
form it. 

In  the  chapter  on  "The  Control  of  Labor,"  something 
is  said  about  the  work  of  the  employment  department  in 
the  hiring  of  men.  There  has  been  a  great  development 
in  this  phase  of  business  management  since  the  days 
when,  as  the  story  goes,  men  were  advertised  for  at  a 
factory  which  was  to  open  on  a  certain  day.  At  the  ap- 
pointed hour  a  crowd  was  waiting  outside  and  when  the 
doors  opened  the  men  rushed  in,  each  of  the  fortunate 
ones  taking  possession  of  a  machine,  like  homesteaders 
at  the  opening  of  a  tract  of  government  land,  and  so 


MANAGEMENT  239 

the  places  were  filled.  It  is  now  the  custom,  however, 
to  subject  all  applicants  for  work  to  a  highly  informative 
preliminary  examination,  by  means  of  which  the  prob- 
able fitness  of  each  for  a  special  kind  of  task  can  be  de- 
termined. That  health  is  a  requisite,  whatever  the  task, 
goes  without  saying. 

New  men  are  shifted  about  until  the  place  is  found 
for  which  they  are  best  suited,  in  case  the  first  assign- 
ment does  not  prove  satisfactory,  and  they  are  then  care- 
fully instructed  in  the  methods  of  working.  Some  con- 
cerns put  new  men  through  a  course  in  a  training  de- 
partment before  they  are  assigned  to  regular  work. 

For  each  important  position,  moreover,  men  are  spe- 
cifically trained  as  alternates,  so  that  the  possible  absence 
or  discharge  of  the  regular  employee  will  be  felt  as  little 
as  possible. 

The  underlying  principle  or  policy  is  this:  that  for 
each  kind  of  work,  there  should  be  secured  the  most 
suitable  kind  of  workman,  the  considerations  being  men- 
tal and  physical  fitness,  natural  aptitude,  and  training. 
With  respect  to  these  considerations  men  are  selected  to 
fit  the  machines  and  methods  of  the  various  tasks.  Grant- 
ing, then,  that  in  this  way  the  best  men  of  the  respective 
classes  are  assembled,  and  their  possibilities  and  their 
limitations  studied  and  understood,  the  machines  and 
methods  are  modified  to  make  them  fit  the  average  work- 
men of  the  respective  classes. 

The  human  element,  as  we  have  noted  above,  is  in 
actual  practice  the  material  which  management  is  most 
actively  concerned  with.  Machines  and  methods  can  be 
adjusted  almost  at  will,  but  the  average  man  of  a  given 


240  PRINCIPLES  OF  BUSINESS 

class,  fitted  for  a  given  kind  of  work,  is  of  certain  con- 
sistent and  impassable  limitations. 

The  spirit  of  co-operation. — If  a  separation  may  be 
made  of  the  means  whereby  a  spirit  of  co-operation  on 
the  part  of  the  workman  may  be  secured,  these  means 
may  be  classified  as  being: 

1.  A  wage  of  relative  contentment,  proportioned  to 
individual  performance;  or  to  group  performance,  if  in- 
dividual performance  cannot  be  measured. 

2.  Unification  of  interests  of  management  and  men, 
which  makes  possible  the  substitution  of  leading  for 
driving. 

A  "Wage  of  Contentment." — By  a  "wage  of  con- 
tentment" is  not  meant  a  wage  as  high  as  the  workman 
would  like  to  have — for  there  would  be  no  limit  to  the 
amount,  in  such  a  case ;  but  such  a  wage,  in  which  work- 
ing conditions  are  also  taken  account  of,  as  the  workman 
will  recognize  to  be  fair,  and  receiving  which  he  will 
look  for  an  increase  in  his  income  in  promotion  to  a  better 
position — and  not  to  higher  wages  for  the  same  work, 
to  be  obtained  perhaps  through  coercive  measures,  such 
as  strikes. 

Men  work  for  wages,  but  that  is  not  all  they  work  for 
and,  far  less,  all  they  live  for.  We  see  them  on  every 
hand  leaving  the  comforts  of  a  possible  routine  life  to 
explore  and  to  experiment.  Dependence,  whether  sought 
out  of  necessity  or  imposed  by  authority,  is  not  the  human 
goal.  Opportunity  to  advance  is  more  eagerly  sought  than 
the  assured  comforts  of  mediocrity.  An  alert  interest  in 
personal  advancement  will  do  more  than  the  lure  of  so- 
cialized recreations.    An  opportunity  to  gain  independence 


MANAGEMENT  241 

and  to  cultivate  self-respect  is  the  first  consideration. 
After  this  may  come  welfare  work  in  its  various  forms, 
accepted  by  the  men  in  the  spirit  in  which  it  is  ofifered. 
Even  illiterate  workmen  are  surprisingly  astute  in  esti- 
mating with  the  sureness  of  instinct  the  innermost  feel- 
ings of  their  employer. 

Leadership. — Men  are  almost  always  willing  to  help, 
but  are  almost  never  willing  to  be  made  to  help.  They 
have  an  aversion  to  being  exploited  or  ''used."  How 
often  have  we  heard  someone  say  "I  am  a  man  who  can 
be  led  but  not  driven."  The  speaker  imagines  that  this 
is  a  characteristic  which  somehow  sets  him  off  from  the 
common  herd,  but  the  truth  is  that  we  are  all  of  the 
same  temperament.  When  we  are  driven,  we  are  "used," 
but  when  we  are  led,  we  are  partners  in  a  common  cause, 

A  j-oung  man  came  into  the  office  of  an  old  friend  of 
the  family,  and  said :  "Judge,  I  am  trying  to  put  over  a 
little  deal,  and  want  you  to  help  me." 

"Certainly,  my  boy,"  answered  the  amiable  old  gen- 
tleman. "I  knew  your  father,  and  will  do  anything  in 
the  world  for  you." 

"Well,  Judge,  it's  like  this:  You  know  these  people 
quite  well,  and  I  thought  maybe  I  could  kind  a  use  you 
as  a  gouge " 

"Use  me!  Use  me,  as  a  gouge?"  shouted  the  Judge. 
"There  is  nobody  on  earth  that  has  the  privilege  of  using 
me  for  anything!" 

Former  Sec.  of  Labor  Wilson,  commenting  upon  the 
difficulty  of  getting  men  to  accept  the  things  provided  for 
them  by  welfare  work,  says  that  a  man  will  rather  live 
in  a  log  cabin  of  his  own,  with  the  poorest  food  and  the 
fewest  comforts,  than  in  a  well-appointed  house  belong- 


'242  PRINCIPLES  OF  BUSINESS 

ing  to  the  company  that  employs  him.  This  is  nothing 
new  in  human  nature.  Dante  expresses  the  same  idea 
when  he  says,  of  the  man  whom  fortune  has  cast  out 
of  his  former  possessions :  "You  will  find  how  salty  is 
the  bread  of  strangers,  and  how  hard  it  is  to  climb  other 
people's  stairs."  If  men  can  feel,  however,  that  in  work- 
ing for  the  business  they  are  working  for  themselves,  a 
true  basis  is  provided  for  the  leadership  which  is  neces- 
sary for  efiicient  co-operation. 

The  end  of  the  matter  is  that  the  time  has  come  in  the 
evolution  of  business  when  management  must  shift  its 
viewpoint,  no  longer  regarding  workmen  and  the  public 
as  something  to  be  "used"  or  exploited  for  the  benefit 
of  the  capital  interests  of  the  business,  but  regarding  it- 
self as  the  means  whereby  all  the  interests  represented 
are  united  in  a  mutual  purpose.  This  imposes  upon  man- 
agement a  new  responsibility. 

The  new  viewpoint. — We  have  seen  that  the  proper 
duty  of  management  is  the  making  of  the  most  profit 
for  the  "employers."  The  question  now  is  beginning  to 
be  asked,  who  are  these  employers?  The  actual  em- 
ployer of  the  manager  or  administrator,  from  the  new 
viewpoint,  is  not  the  capitalist,  but  the  business  which  he 
manages;  that  is,  the  business  as  a  distinct  entity.  The 
capitalist  has  hitherto  held  a  controlling  interest  in  this 
business,  and  has  therefore  assumed  that  the  entire  busi- 
ness existed  for  his  aggrandizement — that  all  the  profit 
was  to  be  his  profit.  Now  come,  so  to  speak,  the  minor- 
ity stockholders — labor  and  the  public — and  call  for  an 
accounting.  They  may  not  be  disposed  to  say  that  the 
shares  must  be  reapportioned;  but  they  do  hold  that  if 


MANAGEMENT  243 

the  capitalist  owns,  for  example,  51  per  cent  of  the  stock, 
he  should  not  be  permitted  to  take  75  per  cent  or  90  per 
cent  of  the  profits.  In  other  words,  it  is  coming  to  be 
recognized  that  labor  and  the  public  have  a  direct  in- 
terest in  every  business  enterprise  and  that  the  manage- 
ment should  represent  not  the  capitalist  interest  exclu- 
sively but  the  several  respective  interests  jointly. 

The  most  enlightened  holders  of  these  respective  in- 
terests realize  that  a  business  must  be  managed  impar- 
tially, with  a  view  to  the  interests  of  all,  if  it  is  to  make 
the  most  profit  for  any  or  each.  A  disproportionate  ad- 
vantage to  the  public,  as  when  railroad  charges  are  too 
low,  will  cause  capital  to  withdraw;  unreasonable  de- 
mands of  labor  work  injury  to  all  concerned;  greed  on. 
the  part  of  capital  drives  away  the  necessary  labor  and 
the  necessary  support  or  patronage  of  the  public. 

At  this  point,  we  may  take  note  of  the  often-heard 
contention  that  since  capital  takes  the  risk  it  is  entitled 
to  the  profit.  Put  in  a  more  forceful  form,  the  argument 
is  that  the  lure  of  profit  is  necessary  to  induce  capital  to 
take  the  risk  of  engaging  in  business.  It  is  probably 
true  that  the  hope  of  an  unusual  profit  does  lead  capital 
to  take  the  initiative  in  developing  new  enterprises,  but 
it  is  also  probable  that  the  proportion  of  the  risk  borne 
by  capital  alone  is  overestimated.  Labor  and  the  public 
also  run  a  risk,  less  apparent  because  more  widely  dis- 
tributed. Again,  if  capital  takes  a  risk  and  loses,  it  puts 
the  blame  upon  "causes  beyond  control."'  If  it  wins, 
however,  it  attributes  success  to  its  own  farsightedness 
and  business  ability,  and  claims  the  profit  as  a  reward. 
Why  should  it  not  be  equally  just  to  attribute  success  to 


244  PRINCIPLES  OF  BUSINESS 

causes  beyond  control ;  or  loss  to  the  absence  of  far- 
sightedness and  business  ability?  The  point  is  this, 
although  the  matter  is  not  of  great  importance — that  loss 
may  be  looked  upon  as  the  penalty  of  incompetence,  of 
engaging  in  an  enterprise  without  having  made  the 
necessary  preparation.  If  this  be  accepted  as  the  ex- 
planation of  business  losses,  tht  "risk"  argument  fails. 
For  the  sake  of  illustration,  the  citizen  who  violates  the 
law  is  specifically  punished,  but  the  one  who  obeys  the 
law  is  not  specifically  rewarded,  but  is  compensated  by 
the  general  advantages  pertaining  to  living  in  a  law- 
abiding  community,  to  the  maintenance  of  which  he  con- 
tributes. We  do  not  say  that  a  man  is  entitled  to  a 
.medal  of  honor  because  by  being  a  citizen  he  runs  the 
risk  of  finding  himself  a  violator  of  the  law  and  in  danger 
of  being  put  in  prison.  This  illustration,  of  course,  is  not 
meant  to  be  taken  as  representing  precisely  a  parallel 
case,  but  only  as  elucidating  the  line  of  reasoning  sug- 
gested. 

"Under  New  Management." — It  would  seem,  then, 
that  business  is  about  to  "reopen  under  new  manage- 
ment." The  new  management  will  reprcoent  the  busi- 
ness as  an  entity,  making  as  much  profit  as  possible  for 
the  business  and,  consequently,  returning  the  largest  divi- 
dends to  capital,  the  highest  wages  to  labor,  and  the 
greatest  benefits  to  the  public.  This  it  will  be  enabled  to 
do  by  creating  or  rather  making  apparent  the  already 
existing  solidarity  instead  of  diversity  of  interests,  so 
that  leading,  or  guiding,  may  be  substituted  for  driving. 

The  basis  of  justice  upon  which  the  new  management 
is  founded  has  already  been  explained — it  is  no  more, 


MANAGEMENT  245 

nor  less,  than  the  principle  of  the  square  deal,  the  re- 
turning to  each  owner  of  the  business  a  profit  in  pro- 
portion to  his  contribution.  The  basis  of  expediency 
also  has  been  pointed  out — the  greatest  production,  and 
so  the  most  profit,  can  be  secured  only  through  the  co- 
operation of  all  concerned,  which  co-operation  can  be 
had  onl}'  by  a  recognition  of  the  oneness  of  the  respective 
interests.  Besides  justice  and  expediency,  we  have  neces- 
sity as  a  basis  of  the  new  management,  in  that  a  cen- 
tralization of  authority  and  control  is  imperative,  for 
only  from  a  single  viewpoint  can  the  necessary  correlation 
and  co-ordination  of  the  functions  of  the  business  be 
made. 

Business,  under  the  new  management,  thus  becomes  a 
truer  democracy  than  it  has  been  before.  While  effi- 
ciency demands  an  autocratic  leadership  or  control,  this 
control  is  not  arbitrary,  but  is  exercised  in  accordance 
with  fundamental  principles,  or  laws,  to  which  the  man- 
agement is  subjected  equally  with  the  workman.  In  serv- 
ing these  laws,  we  are  serving  our  own  ends.  There  is  no 
stifling  of  personal  ambition,  but  each  may  freely  rise 
or  sink  to  his  own  level — rather,  each  will  be  forced  to 
his  own  level. 

Under  this  system,  of  course,  the  law  of  the  survival 
of  the  fittest  must  persist — there  is  no  way  to  repeal  it, 
but  we  come  to  understand  better,  perhaps,  what  fitness 
really  means.  The  most  successful  manager,  from  the 
new  viewpoint,  is  the  one  who  is  best  fitted  to  assemble 
and  interpret  all  obtainable  information  about  the  busi- 
ness and  its  several  owners,  and  who  has  the  sense  of 
justice,  which  enables  him,  in  the  fight  of  this  knowl- 


246  PRINCIPLES  OF  BUSINESS 

edge,  to  dispense  on  every  hand  what  is  generally  recog- 
nized as  the  "square  deal."  This  is  the  kind  of  manager 
that  men  will  work  for  as  if  inspired,  that  investors  will 
entrust  their  money  to,  that  public  opinion  will  support 
in  policies  looking  to  concentration  rather  than  decen- 
tralization of  the  control  of  industry,  and  that  presidents 
will  appoint  in  charge  of  the  nation's  business  when  a 
crisis  demands  that  something  be  accomplished  imme- 
diately. 

Those  who  have  seen,  some  more  clearly  than  others, 
the  coming  of  the  new  management,  have  described  it  as 
being  not  an  evolution  but  a  revolution.  What  they 
mean  by  this  is  that  it  does  not  necessarily  involve  any 
change  in  the  present  structure  of  business;  all  the  neces- 
sary elements  are  about  us,  as  close  as  the  air  we  breathe. 
It  is  a  sort  of  spiritual  conversion,  following  which  we 
look  upon  the  same  world  through  different  eyes — it  is 
merely  a  change  in  the  point  of  view. 

BIBLIOGRAPHY 

Taylor,  F.  W.,  The  Principles  of  Scientific  Management. 

Taylor,  F.  W.,  Shop  Management. 

Thompson,   C.   Bertrand,  Scientific  Management. 

Thompson,  C.  Bertrand,  The  Theory  and  Practice  of  Scient^\c 
Management. 

Babcock,  George  D.,  Taylor  System  in  Franklin  Management. 

Gilbreth,  F.  B.,  Motion  Study. 

Shepard,  George  H.,  The  /Ip'plication  of  Efficiency  Principles. 

Barth,  Carl  G.,  "Slide  Rules  for  the  Machine  Shop  as  a  Part  of 
the  Taylor  System  of  Management,"  Am.  Soc.  of  Mech.  Eng., 
Traiisactious.  1894,  No.  596. 

Diemer,  Hugo,  Factory  Organization  and  Administration. 

Jones,  Edward  D.,  The  Administration  of  Industrial  Enterprises. 

Parkhurst,  F.  A.,  Applied  Methods  of  Scientific  Management. 

Hoxie,  Robert  F.,  Scientific  Management  and  Labor. 

Brandeis,   L.   D..   Scientific  Management  and  the  Railroads. 

Duncaa    John  C,   The  Principles  of  Industrial  Management. 


CHAPTER    XII 

OFFICE  MANAGEMENT 

Office  management  defined. — In  order  that  we  may 
have  a  clear  idea  of  what  is  involved  in  office  manage- 
ment, it  is  necessary  that  we  distinguish  carefully  between 
office  management  and  management  in  general.  The 
office  manager  as  such  has  no  more  to  do  with  the  policies 
of  the  business,  or  with  the  functions  of  producing, 
selling,  financing  and  accounting,  than  the  manager  of  a 
telephone  system  has  to  do  with  the  business  that  is  trans- 
acted over  the  wires  of  the  system.  The  office  renders 
an  indispensable  service,  of  course,  but  this  service  in-^ 
eludes  only  the  providing  of  a  system  of  intercommunica- 
tion between  the  departments  and  subdepartments  of  the 
organization  and  between  the  organization  and  its  en- 
vironment. The  great  mass  of  clerical  work,  commonly 
known  as  "office  work,"  is  no  more  than  the  reducing  of 
the  various  kinds  of  data  to  writing,  for  the  present  or 
future  instruction,  guidance  or  information  of  those  con- 
nected with  the  business  organization. 

What  is  an  "office,"  in  the  common  usage  of  the  term? 
It  is  the  place  where  a  man  regularly  transacts  his  busi- 
ness— where  letters,  telegrams,  telephone  calls  and  other 
messages  can  reach  him,  and  from  which  he  can  send 
them.  Conveniences  are  provided  for  the  excTiange  of 
personal    communications — "deals"    are    made,    confer- 

247 


248  PRINCIPLES  OF  BUSINESS 

ences  are  held,  subordinates  are  summoned  to  receive 
instructions  or  to  give  accounts  of  how  they  have 
succeeded  in  carrying  out  instructions  given  previously. 
Here  also  is  the  '-memory''  of  the  organization,  in  the 
files  of  correspondence,  records  and  statistics.  The  of- 
fice, then,  may  be  regarded  as  being,  essentially,  the 
system  whereby  those  in  authority  may  receive  infor- 
mation as  to  current  and  past  operations,  and  by  means 
of  which  system,  having  made  their  decisions  in  the 
light  of  such  information,  they  may  direct  and  keep  in 
touch  with  future  operations. 

Office  duties. — The  duties  included  in  office  manage- 
ment may  be  regarded  as  being: 

1.  Providing  suitable  office  rooms,  equipment  and 
supplies. 

2.  Providing  a  competent  office  personnel. 

3.  Planning,  assigning  and  supervising  the  perform- 
ance of  the  office  tasks. 

"Lay-out"  of  the  office. — The  "lay-out"  of  the  office 
includes  the  arrangement  of  the  office  with  respect  to  its 
departmental  divisions  and  subdivisions,  with  due  regard 
to  the  possibility  of  expansion  in  the  future,  and  with,  re- 
gard also  to  the  problems  of  lighting,  heating  and  venti- 
lation. 

In  estimating  the  amount  of  floor  space  required,  it 
is  customary  to  make  an  allowance  of  about  100  square 
feet  for  each  employee.  The  number  of  employees  can 
be  estimated  by  an  analysis  of  the  probable  amount  of 
work  to  be  done,  reference  being  made  to  available  data 
as  to  what  constitutes  a  fair   day's   work   for  an  em- 


ObFICE  MANAGEMENT  249 

ployee  of  a  given  class  or  grade/  Office  conditions  are 
so  variable  that  standards  and  methods  will  have  to  be 
v^orked  out,  as  a  rule,  for  each  establishment. 

The  necessary  space  being  provided  fpr,  the  first  con- 
sideration in  the  apportionment  of  the  space  is  that  of 
the  "routing"  of  the  work — the  progress  of  the  most 
important  tasks  from  one  department  of  the  office  to  an- 
other, as  in  the  handling  of  an  order  which  arrives  in 
the  mail  and  w^hich  may  have  tc  pass  through  the  sales 
department,  the  credit  department,  the  manufacturing  de- 
partment, the  shipping  department  and  the  accounting 
department.  The  departments  should  be  arranged,  other 
things  being  equal,  so  that  the  lines  of  communication 
between  them  may  be  as  short  and  direct  as  possible. 
The  sequence  of  operations  should  be  on  the  same  prin- 
ciple as  that  which  governs  the  sequence  of  operations 
in  scientific  management  shops,  where  there  is  little  or 
no  retracing  of  steps,  the  work  progressing  as  nearly 
as  possible  in  a  straight  line  or  continuous  curve.  Guess- 
work must  not  be  depended  upon.  The  system  must  be 
put  into  writing,  and  comparisons  must  be  made  be- 
tween all  reasonably  possible  variations  of  arrangement 

1  The  following  standards  may  be  taken  as  representative  of 
those  used  in  well-managed  offices.  The  table  is  taken  from 
"Standardizing   Office   Work."   Industrial  Management,   July,    191 7. 

Type  of  work  100  per  cent  standard 

Phonographic  transcription  182  square  inches  per  hour 

Form  typewriting  200  square  inches  per  hour 
Addressing  form    (three  lines)         180  addresses  per  hour 

Machine  addressing,   hand    feed  3600  addresses  per  hour 

Circular    enclosing    (one    enclo-  1200  per  hour 

sure) 

Hand   folding  letter   size   sheets  850  per  hour 

Sealing  2400  per  hour 

Stamping  1600  per  hour 

Filing  cards  alphabetically  500  per  hour 


250  PRINCIPLES  OF  BUSINESS 

until  the  lay-out  is  discovered  which  will  involve  a  min- 
imum of  going  to  and  fro  and  which  will  insure,  as  far 
as  possible,  the  elimination  of  all  other  forms  of  dupli- 
cation of  effort.  "Every  little  movement  has  a  burden 
of  its  own." 

Each  official  of  any  importance  will  have  his  indi- 
vidual office — a  private  room  or  a  subdivision  of  a  gen- 
eral office.  In  each  such  office  there  will  be  a  certain 
amount  of  office  work  which  will  be  directly  or  indi- 
rectly under  the  care  of  the  office  manager  as  well  as 
that  of  the  "tenant''  of  the  office. 

Besides  these  individual  offices,  there  will  be,  in  many 
cases,  a  large  room  or  set  of  rooms  where  many  clerks, 
typists  and  other  office  employees  are  assembled.  In 
such  a  room  the  desks  are  most  conveniently  arranged 
in  double  rows,  with  aisles  between,  so  that  clerks  leaving 
their  desks  will  not  disturb  each  other. 

Lighting. — The  fullest  use  should  be  made  of  sunlight 
for  lightiiig  the  office,  with  care  that  private  offices  do 
not  shut  off  the  light,  and  that  the  kinds  of  work  which 
require  the  best  light  are  done  at  the  desks  which  are 
most  favorably  located  in  this  respect. 

When  artificial  light  is  to  be  used,  there  may  be  a 
choice  of  three  lighting  systems — direct,  indirect  and 
semi-indirect. 

The  "direct"  system — in  which  the  light  falls  di- 
rectly on  the  working  plane — is  preferable  where  the 
work  is  unevenly  distributed  throughout  the  office,  or 
where  the  walls  and  ceiling  are  of  a  dark  finish.  Care 
should  be  taken  that  none  of  the  lighting  units  are 
in  the  line  of  vision,  or  bright  enough  to  cause  a  glare. 


OFFICE  MANAGEMENT  251 

It  is  customary,  in  this  system,  to  provide  an  individual 
lamp  for  each  desk. 

The  ^'indirect"  system  is  that  in  which  the  Hght  from 
the  units  is  cast  upon  walls  and  ceiling  and  thence  dif- 
fused over  the  room.  This  system  is  about  50  per  cent, 
more  expensive  in  operation  than  is  a  direct  lighting 
system. 

The  "semi-indirect"  system  is  that  in  which  the  light- 
ing unit  is  protected  by  a  translucent  but  not  transparent 
globe,  through  which  part  of  the  light  falls  directly 
upon  the  working  plane,  the  remainder  of  the  light  being 
diffused  from  walls  and  ceiling  as  in  the  indirect  system. 

If  electric  light  is  used,  the  units  ordinarily  employed 
in  the  systems  described  above  are :  for  direct  lighting, 
lamps  of  about  60  watts;  for  indirect  lighting,  250  to 
500  watts;  for  semi-indirect,  100  watts. 

Sufficient  light,  without  glare  or  reflection  from  pol- 
ished objects,  such  as  highly  polished  furniture  and  the 
like,  is  essential  for  the  performance  of  efficient  work. 
Bad  lighting  causes  eye  strain,  headache  and  lessened 
capacity  for  work,  to  say  nothing  of  the  irreparable  in- 
jury to  the  employee,  if  his  sight  becomes  impaired. 

An  incidental  effect  of  bad  lighting  is  that  upon  san- 
itary conditions.  Light,  other  than  direct  sunlight,  may 
be  of  no  service  directly  as  a  destroyer  of  germs,  but, 
by  making  visible  any  accumulations  of  dirt  in  which 
germs  may  harbor,  it  leads  to  their  removal.  Dirt,  like 
any  other  evil,  must  be  seen  before  it  can  be  dealt  with. 

Ventilation  and  temperature. — Ventilation  is  impor- 
tant, but  less  important  than  temperature,  since  the  de- 
■  vitalizing  effects  of  bad  ventilation  are  due  principally 


252  PRINCIPLES  OF  BUSINESS 

to  the  difficulty  the  body  has  in  maintaining  its  normal 
temperature  of  98.6  degrees  when  the  air  is  humid  as 
well  as  hot,  which  it  becomes  when  there  is  insufficient 
ventilation.  The  body  normally  produces  a  surplus  of 
heat,  which  surplus  it  gets  rid  of  in  two  principal  ways. 
If  the  surrounding  air  is  cool,  it  will  absorb  the  heat 
directly.  If  the  air  is  warm  but  dry,  the  moisture  per- 
spired will  be  evaporated,  in  which  process  heat  is  ab- 
sorbed very  rapidly  by  the  air.  Any  one  who  has  worn 
a  rubber  raincoat  in  warm  weather  knows  how  difficult 
it  is  for  the  body  to  get  rid  of  its  surplus  of  heat  when 
covered  by  a  non-porous  material  which  precludes  evapo- 
ration. Even  a  slight  movement  of  the  surrounding  air, 
however,  presents  to  the  surface  of  the  body  a  cooler  air, 
capable  of  absorbing  more  heat,  and  also  a  drier  air, 
capable  of  absorbing  more  moisture.  In  a  badly  venti- 
lated room,  then,  keeping  the  air  in  motion  is  a  fairly 
good  substitute  for  changing  it ;  the  ideal  condition,  how- 
ever, is  one  where  there  is  an  abundance  of  "fresh"  air 
at  a  temperature  of  68  degrees. 

While  excessive  humidity  is  the  danger  usually  to  be 
guarded  against,  very  dry  air  is  also  injurious.  Warm 
air  can  absorb  more  moisture  than  cold  air,  so  that  when 
air  of  a  temperature  of  say  25  degrees  is  taken  into 
a  room  and  heated  to  70  degrees,  the  humidity  falls 
to  the  point  where  the  air  is  too  dry.  Every  one  has 
noticed  how  the  breathing  of  very  cold  air  tends  to 
**pftrch"  the  throat.  This  is  because  when  the  air  is 
warmed  in  the  lungs  its  moisture-absorbing  power  is 
many  times  increased,  so  that  it  takes  up  the  supply  of 
moisture  from  the  exposed  surfaces  more  rapidly  than 


OFFICE  MANAGEMENT  253 

it  can  be  replenished.  It  is  necessary,  accordingly,  when 
introducing  very  cold  air  into  a  room,  to  provide  means 
for  adding  moisture  to  the  air.  An  old-fashioned  school- 
room practice  which  many  of  us  may  be  familiar  with 
is  the  keeping  of  a  pan  of  water  on  the  heating  stove. 
In  larger-scale  operations,  moisture  may  be  added  to  the 
incoming  cold  air  by  mixing  with  it  the  "exhaust"  steam 
from  the  heating  plant,  or  by  other  suitable  means. 

Noise. — A  detail  of  exceptional  importance  is  the  elim- 
ination of  "distracting"  noises.  It  is  to  be  borne  in  mind 
that  the  most  alert  and  useful  employees  are  the  very  ones 
most  likely  to  be  affected  by  noises  that  "take  their  minds 
off  their  work."  The  general  or  routine  noise  of  the 
office  is  not  distracting,  more  than  is  the  constant  sound 
of  traffic  in  the  streets.  It  is  the  unusual  noise  that 
should  be  inhibited.  The  instinct  of  gregariousness,  as 
well  as  that  of  curiosity,  prompts  the  normal  human 
being  to  Hsten  to  conversation,  even  against  his  (or  her) 
will.  Conversation,  therefore,  in  an  office  should  be 
reduced  to  the  absolute  minimum. 

Office  furniture  and  equipment. — Applying  the  prin- 
ciple of  standardization  to  office  furniture  and  equipment, 
it  can  readily  be  seen  that  uniformity  is  desirable, 
wherever  working  conditions  are  similar.  In  the  item 
of  desks,  for  example,  standardization  would  mean  that 
purchases  in  quantity  could  be  made,  at  a  saving  in  cost, 
that  the  work  of  the  clerks  using  desks  for  similar  pur- 
poses could  be  standardized  with  respect  to  the  manner 
of  performance;  and  that  inspection  of  the  work  and  of 
the  condition  of  the  desks  would  be  greatly  simplified. 

Flat-top  desks,  of  the  "sanitary"  type,  are  preferable 


254  PRINCIPLES  OF  BUSINESS 

to  the  old-fashioned  roll-top  kind,  unless  one  has  a  spe- 
cial need  for  the  high  front,  as  had  a  lawyer  feudist  in 
the  South,  who  while  in  his  office  always  sat  facing  the 
door,  behind  his  roll-top  desk,  the  drawers  of  which  con- 
tained a  sawed-off  shot-gun  and  two  Colt's  45's. 

It  is  impossible  here,  of  course,  even  to  enumerate 
the  many  other  articles  of  office  furniture  and  equipment 
— chairs,  filing  cabinets,  book-cases,  typewriters,  dicta- 
phones, tabulating  machines,  and  the  rest.  These  should 
be  standardized  wherever  possible.  Attention  may  be 
called  to'  the  fact  that  standardization,  however,  is  not 
something  that  is  accomplished  once  and  for  all,  but  that 
it  is  merely  the  selection  of  what  is  best,  in  materials  or 
in  methods,  and  the  consistent  use  of  what  is  best  until 
something  so  much  better  can  be  found  that  it  will  pay 
to  discard  the  old  and  adopt  the  new.  This  is  what 
is  meant  by  "progressive"  standardization. 

With  respect  to  certain  articles  and  processes,  the  stand- 
ards can  be  revised  at  little  cost,  but  in  other  cases  the 
advantage  gained  would  not  compensate  for  the  expense 
of  making  the  change.  This  fact,  of  course,  does  not  jus- 
tify the  office  manager  in  neglecting  to  keep  himself  in- 
formed of  whatever  progress  is  being  made  in  the  devel- 
opment of  office  equipment,  for  only  by  knowing  what 
the  new  things  are,  how  much  they  would  cost,  and  how 
much  they  would  save  in  operating  expense  can  he  be 
in  a  position  to  make  a  revision  of  the  standards  at  the 
proper  time. 

Providing  an  efficient  office  force. — The  general 
problems  of  wages  and  labor  are  considered  in  the 
chapters   of   this   book   under   titles   which   indicate   the 


OFFICE  MANAGEMENT  255 

nature  of  their  contents.  The  problems  of  office  labor 
are  not  essentially  different  from  those  of  labor  in  the 
various  departments.  At  the  risk  of  anticipating  what 
is  set  forth  in  these  special  chapters  on  wages  and 
labor  problems,  we  may  say  that  labor  should  be  hired 
by  specification,  just  as  the  purchasing  agent  makes 
his  purchases  by  specification.  When  a  buyer  purchases 
ink,  for  example,  he  does  not  say  to  the  dealer :  "Send 
me  some  ink."  He  does  not  wait  until  the  ink  arrives 
before  finding  out  whether  it  is  writing  ink  or  copy- 
ing ink,  or  whether  it  is  blue  or  black  or  violet  in 
color.  He  does  not  wait  a  year  or  more  to  ascertain 
whether  the  ink  is  of  a  permanent  hue  or  whether  it  will 
fade.  He  makes  out  a  bill  of  specifications  to  which  the  ink 
must  conform ;  he  makes  his  analyses  or  experiments  be- 
fore purchasing,  not  after.  Yet  in  the  now-becoming- 
obsolete  system  of  hiring  employees  haphazard  and  an- 
alyzing them  afterward,  the  greater  number  must  prove 
unsatisfactory  and  transient,  because  they  do  not  conform 
to  the  requirements. 

It  is  true,  of  course,  that  human  material  is  much 
more  adaptable  to  modified  conditions  than  is  inert  ma- 
terial. At  the  same  time,  any  given  individual  is  natu- 
rally fitted  for  the  performing  of  certain  duties,  and 
naturally  non-fitted  for  the  performing  of  others.  The 
problem  of  the  employer  is  to  ascertain  by  a  series  of 
mental  and  physical  tests  what  positions  applicants  for 
employment  are  naturally  fitted  to  fill,  and  having  se- 
lected the  fit  applicants,  to  give  them  every  assistance  in 
performing  their  duties.  A  course  of  training  may  be 
given  before  the  applicant  is  assigned  to  regular  work. 


2S6.  PRINCIPLES  OF  BUSINESS 

Classification  of  office  tasks. — Keeping  in  mind  our 
explanation  of  the  "office"  as  being  the  system  of  inter- 
communication between  the  departments  and  subdepart- 
ments  of  a  business  organization  and  between  the  organi- 
zation and  its  environment,  we  may  say  that  the  work  of 
the  office  comprises  the  following  larger  subdivisions : 

1.  The  receiving  of  incoming  communications  and 
transmitting  them  to  the  proper  authorities. 

2.  The  transcribing  and  sending  of  outgoing  communi- 
cations. 

3.  The  clerical  work  of  preparing  interdepartmental 
communications. 

4.  The  assembling  of  data,  principally  in  the  files  of 
correspondence,  records,  and  accounts. 

Incoming   communications. — Incoming   communica- 
tions may  be  classified  as  follows: 
'  I,  Letters  and  telegrams. 

2.  Telephone  messages. 

3.  Written  reports  from  within  the  organization. 

4.  Personal  reports  and  communications. 

In  a  large  office  the  volume  of  incoming  mail  is  enor- 
mous. A  certain  Chicago  mail-order  house,  for  example, 
receives  mail  in  such  quantities  that  the  letters  are 
weighed  upon  arrival  in  order  that  an  estimate  may  be 
made  immediately  of  the  amount  of  money  they  contain 
and  of  the  number  of  orders  that  must  be  filled  during 
the  day.  The  number  of  letters  is  so  great  that  it  is 
known  almost  exactly  what  the  ratio  is  between  the 
weight  of  the  letters  and  the  amount  of  money  con- 
tained in  them.  A  million  dollars  is  sometimes  received 
in  a  single  day. 


OFFICE  MANAGEMENT  257 

The  labor  of  handling  and  distributing  incoming  mail 
may  be  divided  into  many  separate  operations,  such  as 
opening;  caring  for  cash  and  other  enclosures;  sorting 
according  to  departments,  and  also  as  to  importance  and 
time  when  attention  is  required;  looking  up  records  of 
customers  whose  orders  are  received;  interpreting  the 
orders;  making  additional  copies  of  orders;  passing 
orders  to  the  sales  department,  and  the  handling  of 
complaints. 

Standardization  of  practice  is  required  in  these,  as 
in  other  tasks,  both  in  respect  of  the  amount  of  work  to 
be  done  and  in  that  of  the  manner  in  which  it  is  done. 
The  heads  of  departments  must  receive  whatever  com- 
munications are  of  a  certain  character  or  degree  of 
importance;  other  communications  can  be  handled  in 
"routine"  practice. 

Outgoing  communications. — Outgoing  communica- 
tions would  be  classified  under  practically  the  same  heads 
as  the  above,  but  in  the  sending  or  delivery  of  messages 
there  are  additional  tasks  involved.  These  additional 
tasks  are,  principally,  in  the  writing  of  letters,  including 
the  taking  of  dictation;  typing;  compilation  of  prescribed 
form  or  "paragraph"  letters;  stamping  and  mailing;  and 
in  the  making  of  duplicate  copies,  by  means  of  carbon 
sheets,  letter  presses  and  other  devices.  In  mailing,  the 
items  must  be  separated  into  special  delivery,  domestic 
and  foreign  mail.  Most  of  the  work  may  be  done  in  the 
general  office,  where  facilities  of  all  kinds  are  accessible, 
but  part  of  the  work  will  be  done  in  the  private  or  special 
departmental  offices  where  the  communications  originate. 

In   order  to   save   postage,   outgoing   mail   to  branch 


258  PRINCIPLES  OF  BUSINESS 

offices  will  be  accumulated  and  sent  in  a  single  envelope, 
as  will  letters  or  other  communications  sent  to  salesmen 
and  other  correspondents.  The  same  principle  will  apply 
to  the  sending  of  telephone  and  telegraph  messages; 
various  matters  can  be  communicated  in  a  single  mes- 
sage or  night  letter. 

For  the  carrying  of  writ'ten  messages  between  depart- 
ments and  for  miscellaneous  purposes  of  a  like  nature, 
the  "office-boy  service"  is  maintained. 

Interdepartmental  communications. — 'Under  inter- 
departmental communications  we  may  include  the  prepa- 
ration of  instruction  cards,  requisitions,  purchase  orders 
and  the  like — also  the  preparation  of  invoices  and  other 
shipping  papers,  which  when  completed  are  included  with 
the  outgoing  communications  mentioned  above.  Here 
also  may  be  included  the  various  notices  of  meetings, 
reminders  of  appointments,  and  other  communications 
of  a  like  nature. 

Standardized  forms  of  records  and  reports. — Rec- 
ords and  reports  are  communications  embodying  the 
results  of  operations  carried  on  under  delegated  au- 
thority, made  usually  by  a  subordinate  to  his  superior. 
Since  the  greatest  value  of  reports  is  in  the  clearness 
with  which  they  show  not  only  what  has  been  done 
during  the  period  covered  by  the  report,  but  also  how 
the  results  compare  with  those  shown  by  reports  for 
earlier  or  later  periods,  standard  forms  of  report  should 
be  used,  so  that  the  manager  or  other  official  receiv- 
ing the  report  may  read  and  compare  it  intelligently, 
with  the  least  loss  of  time.  If  the  manager  is  busy,  he 
may  care  to  examine  carefully  only  certain  features  of 


OFFICE  MANAGEMENT  259 

the  report.  He  must  be  able  to  find  the  features  he  is 
interested  in  without  delay,  and  must  know  that  the 
respective  headings  in  each  successive  report  represent 
the  same  things.  The  office,  as  such,  is  concerned  only 
with  the  clerical  work  involved  in  the  preparation  of  the 
report,  in  its  transmission  to  the  person  who  is  to  receive 
it,  and  in  the  preservation  of  the  report  for  future  ref- 
erence. The  question  of  what  the  report  shall  contain 
is  the  concern  of  the  management,  not  of  the  office.  For 
contents  of   reports,   see   "]\Ianagement." 

Assemblage  of  data. — A  very  important  function  of 
the  office  is  the  accumulation  and  filing  of  data — the 
letters,  records,  and  statistics  serving  as  the  "memory" 
of  the  organization,  and  also  as  a  storehouse  of  informa- 
tion relevant  to  the  various  relations  of  the  organiza- 
tion to  its  environment.  Interpreting  the  function  of  the 
office  consistently  as  being  primarily  a  system  of  com- 
munication, the  office  files  are  the  means  of  conveying  to 
the  various  executives  accurate  reports  of  the  methods 
used  in  and  results  obtained  from  past  operations. 

Filing. — Files  are  classified  accumulations  of  written 
data  preserved  for  future  reference.  The  important  fea- 
ture of  any  filing  system,  of  course,  is  not  the  ease  with 
which  papers  may  be  filed,  but  the  ease  with  which  they 
may  be  found  when  wanted.  Papers  can  be  inserted  in  a 
file  at  leisure,  and  by  clerks  whose  time  is  not  espe- 
cially valuable.  When  a  paper  is  to  be  taken  out  of  the 
file,  however,  the  successful  closing  of  a  "deal"  may  be 
at  stake,  or  in  case  of  a  delay  a  board  of  directors  may 
be  kept  waiting.  It  is  essential,  then,  that  the  filing  sys- 
tem be  a  system  in  every  sense  of  the  word,  and  that 


26o  PRINCIPLES  OF  BUSINESS 

the  filing  clerks  do  their  work  with  the  care  which  its 
importance  demands.  There  should  be  no  delay,  of 
course,  in  returning  papers  to  the  file  after  they  have 
been  taken  out  for  reference,  but  while  it  is  sometimes 
permissible  to  have  data  removed  from  the  files  by  any 
authorized  person,  not  necessarily  a  file  clerk,  only  the 
file  clerk  should  be  permitted  to  replace  them. 

It  is  preferable  that  a  central  filing  system  be  adopted, 
rather  than  one  in  which  each  department  keeps  its 
own  files.  There  are  many  papers  which  may  be  needed 
for  reference  by  more  than  one  department,  and  the  cen- 
tral file  is  accessible  to  all.  Unity  of  arrangement  can 
be  effected  by  a  single  filing  clerk  with  his  assistants, 
and  the  filing  system  must  be  described  in  the  office 
manual  so  that  any  one  can  find  any  papers  desired  in 
case  of  the  absence  of  the  filing  clerk.  Ease  of  filing 
itself  should  not  be  overlooked.  Much  labor  may  be 
saved  by  providing  not  only  a  convenient  system,  but 
ample  space.  Crowded  files  cause  a  waste  of  time  en- 
tirely out  of  proportion  to  the  value  of  the  space  which 
may  be  saved  by  crowding. 

Perhaps  for  the  reason  that  filing  is  to  be  classed  with 
planning  and  other  "unproductive"  work,  it  has  too  often 
been  put  in  the  care  of  the  lowest-priced  and  most  ineffi- 
cient employees.  The  employment  department  of  one  of 
the  largest  corporations  in  the  country,  for  example,  en- 
trusted its  files  to  a  couple  of  half-grown  office  boys. 
The  result  was  almost  complete  demoralization.  The 
files  contained  some  70,000  applications,  rate-cards  and 
other  records,  which  these  boys  had  learned  to  handle 
by  certain  labor-saving  devices  invented  by  themselves. 


OFFICE  MANAGEMENT  261 

It  became  necessary  to  employ  a  filing  expert  and  staff 
to  reorganize  the  work,  whereupon  it  was  put  in  charge 
of  a  young  woman  with  six  girl  helpers.  Even  after 
that,  the  office  boys,  passing  by,  would  say,  derisively, 
"Two  of  us  used  to  do  all  that  work." 

Classification  before  filing. — A  scheme  of  classifica- 
tion must  be  adopted  and  adhered  to.  This,  of  course, 
is  part  of  the  filing  system.  In  the  filing  of  letters,  for 
example,  care  should  be  taken  that  communications  from 
different  representatives  of  the  same  house  are  filed  to- 
gether under  the  letters  or  figures  representing  the  house, 
and  not  separately  under  the  names  of  the  individuals. 
The  data  to  be  filed  should  be  sorted  before  filing  begins. 
As  an  example  of  the  classification  of  correspondence, 
we  may  quote  the  following,  taken  from  the  office  manual 
of  the  Westinghouse  Electric  and  Manufacturing  Com- 
pany^ : 

Our  files  are  divided  into  the  following  classes : 

1st.  Orders  received  for  material  and  correspond- 
ence pertaining  thereto. 

2nd.  Letters  bearing  upon  an  important  subject  and 
for  which  we  have  constant  use. 

3rd.  Correspondence  pertaining  to  the  solicitation  of 
business. 

4th.  Correspondence  relating  to  costs  and  prices. 

5th.  Correspondence  relating  to  issue  of  publications. 

6th.  Books, 

7th.  Correspondence  which,  after  having  attention, 
is  of  small  importance  or  unlikely  to  require 
further  attention. 

^  \V.  H.  Leffingvvell,  Scientific  Office  Management,  A.  W.  Shaw 
and  Company. 


262  PRINCIPLES  OF  BUSINESS 

8th.  Correspondence  which,  after  having  attention, 
is  of  no  value  and  never  referred  to. 

Flat  and  vertical  filing. — Flat  filing  is  rarely  to  be 
recommended,  except  for  temporary  or  special  purposes. 
Examples  of  flat  filing  are  seen  in  the  filing  of  bills  and 
other  papers  on  a  spindle,  or  in  the  keeping  of  letters 
fiat  in  the  drawer  of  a  desk.  Vertical  files  are  those  in 
which  the  papers  are  held  upright,  with  guides  at  in- 
tervals to  support  the  papers  and  to  indicate  the  index 
letters  or  numbers  preceding  or  following. 

Filing  systems. — In  a  vertical  file,  data  may  be  filed 
alphabetically,  numerically,  or  geographically. 

The  alphabetical  system  is  the  simplest  and  is  the  best 
for  small  files.  A  card  index  is  not  required,  but  refer- 
ence is  made  directly  to  the  names  on  the  folders  in  the 
file.  As  the  names  increase  in  number,  however,  it  be- 
comes more  and  more  difficult  to  keep  the  proper  alpha- 
betical order.  This  type  is  not  suited  for  expansion,  as 
the  guide  letters  must  be  increased  in  number  as  the  file 
grows  larger,  or  else  too  complex  a  system  of  guide  let- 
ters must  be  used  at  first. 

In  the  numerical  filing  system  each  article  filed  bears 
a  number.  It  is  necessary  to  maintain  an  alphabetical 
card-index  in  connection  with  the  numerical  file.  Under 
this  system,  correspondence  is  filed  in  separate,  numbered 
folders  for  each  correspondent. 

A  combination  of  the  alphabetic  and  numerical  sys- 
tems is  that  in  which  data  are  filed  alphabetically,  such 
items  as  belong  together  being  placed  in  numbered  fold- 
ers in  numerical  sequence.  If  desired,  a  geographical 
or  a  subject  basis  of  classification  can  be  adopted,  titles 


OFFICE  MANAGEMENT  263 

being  filed  alphabetically  within  the  geographical  or  sub- 
ject divisions. 

The  geographical  system  is  used,  practically,  only  for 
filing  correspondence  with  branch  offices  or  sales  dis- 
tricts. When  it  is  desired  to  keep  together  all  the  cor- 
respondence pertaining  to  certain  special  subjects,  folders 
of  different  colors  may  be  used. 

The  Dewey  Decimal  System. — The  Dewey  Decimal 
Classification  is  widely  known  through  its  use  in  libraries. 
In  various  modified  forms  it  is  suitable  for  use  in  office 
filing-systems.  Titles  are  indexed  alphabetically  and 
numbers  assigned  indicating  the  subject  and  subdivision 
under  which  the  item  is  to  be  filed.  Ten  principal  sub- 
jects may  be  designated  by  the  numbers  000,  100,  200, 
and  so  on  up  to  900.  Nine  of  the  subject  titles  may  be 
specific,  covering  separate  branches  of  the  subject,  while 
one  may  be  reserved  for  data  of  a  general  or  miscella- 
neous nature,  not  properly  to  be  included  under  the 
specific  titles.  The  larger  subdivisions  under  each  title 
will  be  numbered  by  tens,  as:  no,  120,  130,  and  so  on 
up  to  190.  Lesser  subdivisions  will  be  numbered,  for 
example:  in,  112,  113,  and  so  on.  As  many  subdivi- 
sions of  these  as  may  be  desired  may  be  made  by  using 
decimal  series^  as:  121. i;  121. 2;  or:  121. 12,  121. 21,  and 
so  on,  to  as  fine  a  subclassification  as  is  necessary. 

It  is  advisable,  if  not  necessary,  that  each  series  of 
numbers  represent  subdivisions  co-ordinate  in  rank. 

Disposing  of  obsolete  data. — Since  for  convenience 
the  files  should  be  kept  as  small  and  simple  as  possible, 
it  is  customary  to  maintain  three  sets  of  files,  one  for 
"live"  data,  often  referred  to;  one  for  "semi-live"  data; 


264  PRINCIPLES  OF  BUSINESS 

and  a  "storage"  file.  It  is  the  practice  to  keep  corre- 
spondence in  the  Hve  file  for  one  year;  in  the  second  file 
for  another  year;  and  in  the  storage  file  for  five  years, 
at  the  expiration  of  which  period  it  is  destroyed. 

The  "tickler"  file.— The  "tickler"  file  is  used  for  the 
filing  of  data  that  require  particular  attention  or  that 
must  be  brought  up  for  attention  at  some  particular  time. 
It  is  probable  that  the  name  "tickler"  is  a  contraction  or 
corruption  of  "particular."  The  paper  requiring  atten- 
tion is  placed  in  an  ordinary  correspondence  folder  and 
marked  "Tickler  File,"  with  the  date  and  the  name  of 
the  person  who  must  give  it  his  attention  upon  that  date. 
These  folders  are  kept  in  chronological  order  and  each 
day  the  file  clerk  takes  out  the  folders  for  the  day  and 
sends  them  to  the  persons  designated.  This  system  is 
frequently  used  in  making  collections,  as  described  in  the 
chapter  on  "Credit" — cards  being  placed  in  the  file,  indi- 
cating the  dates  upon  which  accounts  are  due  or  upon 
which  delinquents  have  agreed  to  pay. 

The  card  index. — In  connection  with  certain  filing 
systems  and  for  various  other  purposes  card  indexes  must 
be  kept.  These  may  be  in  the  form  of  cards  in  trays,  or 
may  be  of  the  "visible"  type,  in  which  cards  in  series, 
each  with  its  finding  name  written  on  the  upper  edge,  are 
arranged  so  that  each  stands  a  little  higher  than  the  one 
preceding.  Instead  of  being  in  trays,  the  cards  may  be 
hung  on  a  display  stand. 

Business  libraries. — Besides  the  filing  of  correspond- 
ence, records  and  other  data  pertaining  more  strictly  to 
routine  operations,  many  establishments  maintain  special 
libraries  of  business  books  for  the  facilitating  of  research 


OFFICE  MANAGEMENT  265 

work  and  the  educational  advancement  of  their  employees. 
In  a  library  of  this  kind,  there  will  be  filed  not  only  the 
scientific,  technical  and  other  books  and  magazines  to 
which  access  is  desired,  but  also  publications  such  as  trade 
journals  and  catalogues. 

Standard  catalogue  sizes. — Catalogues  will  be  filed, 
whether  or  not  a  "'special  library"  is  maintained.  It 
is  evident  that  if  catalogues,  especially,  could  be  stand- 
ardized as  to  their  dimensions  other  than  thickness,  or 
number  of  pages,  the  problem  of  filing  would  be  greatly 
simplified.  It  might  not  be  necessary  or  even  advanta- 
geous to  adopt  only  one  size  as  standard.  There  might 
be  several  standard  types.  The  Purchasing  Agent  has 
been  conducting  a  movement  for  the  standardization  of 
catalogues,  and  has  received  not  a  little  encouragement.^ 

It  would  seem  that  no  one  would  dispute  the  advan- 
tages of  catalogue  standardization;  the  difficulty  is  in  get- 
ting the  policy  adopted.     Each  house  strives  to  get  out 

^Through  the  efforts  of  The  Purchasing  Agent,  a  national  con- 
vention of  persons  interested  was  held  in  May,  1918;  at  this  con- 
vention three  standard  sizes  were  adopted :  6x9,  7J^  x  lo^^,  and 
8x11. 

The  size  yYz  x  105^,  which  is  recommended  for  the  use  of  pur- 
chasing agents,  is  a  so-called  "hypotenuse  oblong."  The  hypotenuse 
oblong  has  the  peculiarity  of  maintaining  the  same  ratio  of  breadth 
to  length  however  many  times  it  may  be  folded  or  doubled.  To 
make  a  size  of  sheet  which  is  designated  as  an  "hypotenuse  ob- 
long," all  that  is  necessary  is  to  construct  a  right-angled  triangle 
of  which  each  of  the  two  sides  is  equal  to  the  width  of  the  sheet 
which  is  to  be  used.  The  third  side  of  this  right-angled  triangle 
— the  hypotenuse — will  be  the  length  of  the  sheet  desired.  A  cata- 
logue of  the  hypotenuse  oblong  type  can  be  reproduced  in  smaller 
or  larger  sizes  without  altering  its  proportions  and  without  the 
waste  of  paper  which  might  otherwise  be  incurred  in  cutting,  since 
the  size  of  sheet  used  in  the  original  edition  will  cut  to  half  or 
quarter  sizes  without  waste.  For  discussions  of  catalogue  stand- 
ardization, see  articles  in  The  Purcliasiiig  Agent,  June  and  July, 
1918,  particularly  "The  Hypotenuse  Oblong  as  Affecting  a  Uni- 
versal Catalogue  Size,"  by  Fred  Schulder,  in  the  July  issue. 


266  PRINCIPLES  OF  BUSINESS 

a  catalogue  that  is  "distinctive,"  but  on  account  of  the 
difficulty  of  filing  catalogues  of  many  shapes  and  sizes, 
most  are  thrown  away.  It  is  probable  that  a  standard 
catalogue  in  the  file  would  be  of  more  value  to  the  pub- 
lisher than  a  distinctive  catalogue  in  the  waste  basket. 

The  assigning  of  office  tasks. — In  order  that  office 
tasks — of  which  those  mentioned  in  the  foregoing  pages 
are  fairly  representative — may  be  assigned  intelligently, 
with  the  greatest  economy  of  effort,  an  adaptation  of 
the  principles  of  scientific  management  should  be  made. 
Scientific  management,  of  course,  is  not  something  that 
can  be  purchased  ready-made  and  installed  like  an  adding 
machine  or  other  office  device.  The  application  of 
scientific  management  methods  involves,  in  the  first  place, 
a  thoroughgoing  standardization  and  classification  of  all 
office  tasks.  Such  a  standardization,  obviously,  cannot 
be  made  without  an  orderly  arrangement  of  the  duties 
of  the  various  executives,  out  of  which  duties  arise  those 
of  the  office  manager  and  his  employees.  When  the 
duties  of  the  executives  are  systematized  and  performed 
in  a  regular  manner,  it  should  be  possible  to  organize, 
the  resultant  office  duties  with  a  corresponding  efficiency. 

The  principle  of  functionalized  organization  is  a  very 
simple  one.  Every  organization  is  functionalized  to  some 
extent.  The  more  complete  the  functionalization,  the 
more  closely  the  organization  approaches  the  type  de- 
manded by  scientific  management. 

The  larger  divisions  of  the  work  which  must  be  done 
are  easy  to  perceive.  They  form  the  main  "departments." 
Scientific  management,  however,  is  not  content  with  a 
separation  of  duties  into  several  main  departments,  in 


OFFICE  MANAGEMENT  267 

which  duties  may  be  so  varied  that  each  worker  may  have 
a  number  of  unorganized  and  almost  unrelated  tasks  to 
perform.  The  duties  within  each  department  must  be 
studied  and  classified,  and  assembled  into  minor  depart- 
ments, until  each  task  is  analyzed  into  its  basic  parts, 
until  each  operation  can  be  subdivided  no  further.  The 
one  best  way  of  performing  each  separate  operation  is 
then  determined,  and  like  operations  are  grouped  into 
tasks,  each  task,  therefore,  being  composed  of  opera- 
tions which  certain  workers  or  classes  of  workers,  chosen 
for  their  natural  or  acquired  fitness,  are  selected  to  per- 
form. By  constant  practice  in  performing  the  same  op- 
erations a  degree  of  skill  is  attained  which  is  impossible 
where  the  worker  has  a  number  of  varied  duties. 

Scientific  management,  then,  applied  to  office  work, 
implies  essentially  a  high  degree  of  specialization  in  the 
division  of  labor.  Too  much  specialization,  however, 
may  require  the  expenditure  of  more  energy  to  keep  the 
system  in  operation  than  can  be  conserved  by  the  system, 
especially  in  view  of  the  fact  that  office  employees  must 
frequently  be  replaced,  and  new  workers  trained  in  un- 
familiar methods  of  working.  The  office  manager  must 
decide  at  what  point  further  specialization  would  become 
unprofitable. 

In  some  large  offices,  especially  in  cases  where  the 
first  consideration  is  to  get  the  work  done  not  as  cheaply 
as  possible,  but  as  quickly  as  possible  (as  in  a  mail-order 
business,  where  orders  must  be  filled  promptly),  the 
workers  are  organized  into  groups  or  "teams,"  each 
group  taking  certain  tasks  and  each  member  of  the  group 
taking  certain  subdivisions  of  the  task,  so  that  each  task 


268  PRINCIPLES  OF  BUSINESS 

is  performed  rapidly  in  a  sequence  of  operations  per- 
formed by  the  respective  workers  in  the  group.  A  dis- 
advantage of  such  a  system  is  that  if  a  single  member 
of  the  group  or  "team"  is  absent,  the  w^ork  is  disorgan- 
ized. 

Whatever  system  of  distribution  of  tasks  may  be 
adopted,  the  work  should  be  carefully  planned  in  ad- 
vance, and  the  more  important  details  given  priority. 
When  the  tasks  are  studied  and  classified  a  chart  ot 
organization  should  be  drawn  up  and  a  schedule  of  op- 
eration constructed  and  adhered  to.  The  schedule  of 
operation  will  include  all  regular  duties,  both  routine  and 
periodical.  An  individual  schedule  should  be  made  up 
for  each  employee.  Not  all  the  work  can  be  reduced 
to  routine,  but  if  the  regular  duties  are  well  organized 
special  duties  can  be  more  easily  taken  care  of. 

As  noted  above,  an  intelligent  organization  of  the 
work  of  the  office  is  possible  only  when  the  work  of  the 
executives  has  been  systematized.  No  part  of  a  business 
can  be  complete  in  itself. 

Too  much  stress  cannot  be  laid  upon  the  fact  tliat  not 
only  must  methods  be  standardized,  but  also  the  amounts 
of  work  which  each  employee  is  to  perform.  It  is  safe 
to  say  that  in  the  average  office,  where  a  number  of 
clerks  are  employed,  some  will  do  twice  or  three  times 
as  much  work  as  will  others.  Those  whose  efficiency  is 
low  may  be  handicapped  by  a  lack  of  organization  of 
their  duties,  or  by  lack  of  training,  or  by  physical  or 
mental  unfitness  for  their  tasks.  In  any  case,  the  office 
manager  should  know  how  much  work  each  employee 
accomplishes,  and  how  this  amount  compares  with  the 


OFFICE  MANAGEMENT  269 

amount  which  he  should  accompHsh.  Obviously,  a  sys- 
tem of  work-measurement  must  be  devised,  with  the  al- 
ternative of  unfairness  to  the  employee,  as  well  as  of 
loss  to  the  employer. 

BIBLIOGRAPHY 

Schulzc,  J.  W.,    The  American   Office. 

Leffingwell,   W.    H.,   Scientific    Office   Management. 

Nicholson,  J.   L.,   Factory   Organisation  and  Costs. 

Scott,  Walter  Dill,  Increasing  Human  Efficiency  in  Business. 

Cope,  Edward  A.,  Filing  Systems. 

McCord,  James,  A  Tc.vthook  on  Filing. 

Parsons,   C.   C,   Office   Organization  and  Management. 


CHAPTER    XIII 

WAGES 

Definition  of  wages. — Wages,  in  the  broadest  sense, 
are  the  laborer's  share  of  the  products  of  industry — the 
laborer,  for  our  purpose,  being  anyone  who  receives  a 
stated  remuneration  in  exchange  for  his  services. 

While  we  are  accustomed  to  think  of  wages  in  terms 
of  money,  it  is  obvious  that  wages  in  reality,  consist  not 
of  money,  but  of  the  satisfactions  which  the  money  wage 
enables  the  recipient  to  obtain,  together  with  such  other 
satisfactions  as  may  accrue  to  the  recipient  as  a  result 
of  the  circumstances  or  conditions  of  his  employment. 
Agreeable  surroundings,  relative  immunity  from  hazards 
to  health  or  safety,  permanence  of  employment,  pros- 
pects of  promotion,  protection  in  case  of  misfortune — 
all  these  must  be  counted  as  part  of  the  wage. 

The  products  of  industry. — The  ultimate  aim  of  in- 
dustry is  the  production  not  of  wealth  but  of  human 
happiness.  Since  the  creation  of  an  abundance  of  eco- 
nomic goods,  however,  is  the  most  practical  means  of  in- 
suring the  maximum  of  human  welfare  or  happiness, 
industry  devotes  itself  immediately  to  the  production  of 
economic  goods. 

Distribution  of  the  products  of  industry. — To  those 
who  have  assisted  in  producing  them,  the  products  of  in- 
dustry are  distributed  directly  in  the  form  of  interest, 
rent,  wages,  profits  and  taxes.     These  returns  may  be 

270 


WAGES  271 

regarded  as :  interest  and  rent,  to  the  capitalist ;  wages, 
to  the  laborer;  profits,  to  the  enterpriser,  "business  man," 
or  employer;  and  taxes,  to  the  public.  The  public,  of 
course,  is  made  up  of  capitalists,  employers  and  laborers 
— principally,  however,  of  laborers.  Although  graduated 
taxes  on  income  were  instituted  as  revenue  and  not  as 
regulation  measures,  it  is  to  be  presumed  that  they  will  be 
continued  in  some  form  as  a  permanent  feature  of  the 
machinery  of  wealth-distribution,  tending  to  equalize  the 
returns  to  those  engaged  in  industry  in  whatever  capacity. 
At  this  point  we  cannot  consider  the  many  economic 
problems  involved  in  the  distribution  of  wealth.  It  is 
necessary,  however,  that  we  bear  in  mind  that  wages  do 
not  stand  by  themselves,  but  are  closely  related  to  the 
various  other  forms  in  which  the  products  of  industry 
are  distributed.  While  the  ratio  of  distribution  is  af- 
fected somewhat  by  bargaining,  the  wage  level  depends 
primarily  upon  the  abundance  or  scarcity  of  goods.  It  is 
so  obvious  as  to  be  scarcely  worth  noting,  that  high 
money-wages  do  not  necessarily  mean  high  wages.  The 
prices  of  goods  and  those  of  labor  tend  to  rise  and  fall 
together,  so  that  while  the  laborer  may  receive  at  vari- 
ous times,  for  the  same  amount  of  work,  wages  of  $1, 
$2,  or  $3,  these  are  merely  various  forms  of  conveying 
to  him  the  title  to  a  certain  proportion  of  industry's 
distributable  goods — say  1/3,  2/6,  or  3/9.  Our  concep- 
tion of  the  distribution  of  the  products  of  industry  as 
a  whole  will  not  be  altogether  inaccurate  if  we  imagine 
the  enterpriser,  business  man,  administrator,  or  employer 
as  custodian  of  the  world's  distributable  goods,  issuing 
them  upon  requisitions  presented  by  the  several  claimants 


272  PRINCIPLES  OF  BUSINESS 

— capital,  labor  and  the  public — the  business  man  or  em- 
ployer himself  being  the  residual  claimant,  and  the 
amount  of  goods  covered  by  each  requisition  being  the 
result  of  bargaining  between  the  several  claimants,  society 
acting  as  arbiter  in  cases  where  an  agreement  cannot  be 
reached.  The  bargaining  is  in  effect  a  valuation  of  the 
contributions  to  industry  made  by  the  respective  claimants 
of  the  products  of  industry.  Value  is  determined,  of 
course,  by  desirability  on  the  one  hand,  and  scarcity  on 
the  other  hand — that  is.  by  demand  and  supply. 

High  productivity  means  high  wages. — The  prob- 
lem of  wages,  then,  is  clearly  one  of  two  distinct  phases — 
production  and  distribution.  Failure  to  differentiate 
between  these  phases  of  the  wage-problem  has  led  to 
incalculable  economic  waste  and  to  a  corresponding  de- 
pression of  the  level  of  wages.  To  put  the  matter  briefly, 
the  earning  of  wages  is  a  question  of  production ;  the 
payment  of  wages,  one  of  distribution.  However  un- 
just the  distribution  may  seem  to  be,  disagreements  as  to 
distribution  must  not  interfere  with  production,  for  in 
high  production  lies  the  only  hope  of  high  wages  as  well 
as  of  high  profits.  If  two  men  on  their  way  to  market 
with  a  load  of  perishable  goods  find  themselves  unable  to 
agree  beforehand  as  to  the  division  of  the  proceeds,  it  is 
better  for  them  to  unite  their  efforts  to  place  the  goods 
upon  the  market,  and  to  defer  their  quarrel  until  after  the 
goods  are  sold — rather  than  to  fail  perhaps  to  get  the 
goods  to  market  at  all.  Various  legal  and  other  meas- 
ures of  redress  are  open  to  the  injured  party,  if  an  ami- 
cable agreement  can  not  be  reached. 

The  limits  of  wages. — Assuming  that  goods  are  pro- 


WAGES  -.-3 

duced  in  quantities  at  least  sufficient  for  the  bare  support 
of  the  human  race,  wages,  at  their  lower  level,  are  what 
the  laborer  must  receive  in  order  to  subsist;  at  their 
higher  level,  they  are  what  the  employer  can  pay  without 
sacrificing  all  of  his  profit.  In  emergencies,  of  course, 
the  employer  may  sacrifice  his  profit  and  even  a  part  of 
his  accumulated  capital,  rather  than  let  his  enterprise  lose 
its  going-concern  value.  The  laborer  may  accept,  tem- 
porarily, something  less  than  his  cost  of  subsistence,  this 
being  preferable  to  nothing  at  all.  Between  these  limits, 
bargaining  takes  place,  and  by  this  means  the  actual  rate 
of  wages  is  fixed.  Obviously,  it  is  to  the  interest  of  all 
concerned  to  keep  these  limits  as  far  apart  as  possible. 
This  is  merely  another  way  of  saying  that  productivity 
should  be  maintained  at  its  maximum.  The  human  pack 
will  not  fight  over  the  carcass  of  profit — at  least,  not  with 
any  great  violence— so  long  as  there  remains  enough  for 
all.  AVhen  only  the  bones  are  left,  they  will  turn  against 
each  oth^r. 

Incidentally,  this  situation  constitutes  the  great  argu- 
ment for  scientific  management  and  for  labor-saving  ma- 
chinery in  general.  The  increased  productivity  resulting 
from  labor-saving  methods  widens  the  margin  of  safety 
between  the  upper  and  lower  limits  of  wages.  The  ques- 
tion of  whether  or  not  improvements  in  the  means  of 
production  will  continue  to  outrun  the  increase  in  pop- 
ulation brought  about  by  the  greater  abundance  of  eco- 
nomic goods  made  possible  by  the  improved  means  of 
production,  is  one  which  the  future  must  answer.  It  is 
likely  to  be  a  vital  question  again,  as  it  was  in  the 
days  before  power-machinery  was  invented  and  before 


274  PRINCIPLES  OF  BUSINESS 

transportation  made  accessible  new  fields  of  production. 
For  the  present,  we  must  regard  maximum  production  as 
being  the  prime  object  of  industry,  regardless  of  its  pos- 
sible effect  on  future  population  and  future  wages — max- 
imum production,  so  long  as  goods  are  so  scarce  that 
procuring  the  means  of  subsistence  is  a  difficult  matter 
for  many  of  tlie  human  family. 

What  is  a  fair  wage? — Theoretically,  perhaps,  a  fair 
wage  would  be  the  money-equivalent  of  what  the  laborer 
has  produced — what  he  has  added  to  the  total  supply  of 
goods.  The  production  of  goods,  however,  cannot  be 
segregated  into  the  outputs  of  labor  and  capital,  respec- 
tively. It  is  a  joint  production.  One  without  the  other 
couid  produce  nothing.  Even  if  the  production  attribu- 
lable  to  capital  as  a  whole  could  be  segregated  from  that 
attributable  to  labor  as  a  whole,  it  would  be  impossible 
to  determine  even  approximately  the  value  of  any 
laborer's  individual  or  specific  contribution.  Different 
workers  are  found  at  successive  stages  of  the  process  of 
production,  and  no  one  can  tell  which  worker's  services 
are  the  most  valuable,  measured  in  terms  of  output.  The 
products  themselves  are  scattered  far  and  wide.  Some 
are  consumed  within  a  relatively  short  time;  others  are 
stored  for  the  future.  Some  classes  of  products  are  con- 
sumed directly;  others  are  used  in  further  production. 
The  laborer  must  be  paid  in  advance  of  the  utilization  of 
his  product — some  one  must  discount  the  value  of  his 
services  and  assume  a  certain  risk.  Obviously,  a  search 
for  the  wage  which  is  fundamentally  fair-based  upon  the 
laborer's  contribution  to  industry — can  be  little  more  than 
an  interesting  intellectual  pursuit,  for  the  fair  wage,  as 


WAGES  275 

such,  does  not  exist.  For  fairness  we  must  substitute  ex- 
pediency. A  wage  which  gives  relative  contentment  to 
the  worker  and  which  leaves  the  employer  a  reasonable 
profit — the  wage  and  the  profit  being  in  each  case  suffi- 
cient to  incite  the  worker  and  the  employer  to  co-operate 
in  carrying  on  a  maximum  production,  may  be  found  by  a 
series  of  trials  or  experiments,  and  may  be  called,  arbi- 
trarily, a  fair  wage. 

In  the  practical  ascertainment  of  such  a  fair — that  is, 
expedient — wage,  a  base  or  minimum  wage  is  taken,  rep- 
resenting the  prevailing  rate  of  wages  at  a  given  time 
for  average  workers  under  average  conditions,  and  to 
this  base  wage  is  added  an  amount  corresponding  to  the 
value  of  the  performance  of  the  individual  laborer  in  its 
variation  from  average  performance.  The  base  wage  is 
merely  assumed  to  be  fair ;  the  additions  to  the  base  wage 
can  be  calculated,  however,  with  scientific  accuracy,  with 
allowances  for  length  or  continuity  of  the  laborer's  ser- 
vice, for  variations  in  the  cost  of  living,  and  for  other 
factors  as  well  as  the  specific  performance  of  the  in- 
dividual.^ 

If  after  the  payment  of  a  "fair"  wage  to  the  laborers, 
ascertained  in  the  manner  described  above,  the  employer 
is  left  with  a  profit  "unreasonably"  large — that  is,  larger 
than  employers  ordinarily  secure — competition  will  set  in 
more  strongly,  reducing  the  selling  price  of  the  product; 
or  direct  action  may  be  taken  by  the  public  through  taxa- 
tion or  price-fixing,  to  secure  for  the  public,  or  in  some 
cases  for  the  wage-earner,  the  "unreasonable"  portion  of 
the  employer's  profit. 

^See  the  general  wage  equation  of  the  Franklin  Motors  Company, 
P-  303. 


276  PRINCIPLES  OF  BUSINESS 

For  the  capable  worker,  then,  the  expedient  wage  comes 
to  be  regarded  as  the  fair  wage.  What,  however,  shall 
we  regard  as  a  fair  wage  for  those  who  are  not  capable 
— a  fair  wage  for  the  world's  ineffectives?  This  ques- 
tion also  is  one  which  the  future  must  answer. 

Wage-policies  of  capital,  labor  and  the  public. — It 
is  apparent,  for  the  maintenance  of  maximum  production, 
that  there  is  need  for  the  establishment  of  a  common 
viewpoint  from  which  wage  and  labor  questions  in  gen- 
eral may  be  regarded  by  capital,  labor  and  the  public. 
For  the  purpose  of  the  present  discussion  we  may  regard 
capital  as  comprising  both  capitalists  and  employers,  since 
the  latter  are  usually  owners  as  well  as  users  or  borrowers 
of  capital.  The  interests  of  each  of  these  lie  in  the  great- 
est production — about  this  there  is  no  question.    . 

Individual  laborers  and  individual  capitalists  are  not 
content,  however,  to  share  merely  in  a  general  benefit. 
They  desire  to  obtain,  each  for  himself,  a  peculiar  per- 
sonal advantage.  Instead  of  confining  their  distribution 
disputes  to  the  fields  of  distribution,  they  carry  them 
over  into  the  fields  of  production.  Manipulation  of  pro- 
duction for  the  sake  of  forcing  an  abnormal  distribution 
can  result  only  in  economic  loss  which  eventually  falls 
even  upon  those  who  have  made  a  temporary  gain. 

Since  those  in  control  of  production  are  in  a  strategic 
position  with  respect  to  the  control  of  distribution,  it  is 
not  surprising  that  control  of  production  is  one  of  the 
principal  objectives  likewise  of  capital  and  of  labor.  The 
means  by  which  control  is  attempted  are  touched  upon 
in  the  chapter  on  "Control  of  Labor."  There  the  neces- 
sity of  control  from  a  single,  impartial  viewpoint  is  em- 


WAGES  277 

phasized,  as  it  is  also  in  the  chapter  on  "Management." 
Here  we  may  consider,  briefly,  the  poHcies  of  capital  and 
labor,  respectively,  toward  the  wages  question,  and  give 
also  a  brief  resume  of  the  policy  of  the  public,  as  evi- 
denced by  recent  legislation. 

Wage-policies  of  capital. — Capital  undoubtedly  re- 
gards the  services  of  the  laborer  primarily  as  a  commod- 
ity, to  be  purchased  at  the  lowest  price.  The  human 
viewpoint,  however,  is  not  altogether  absent;  the  welfare 
of  the  laborer,  as  a  human  being,  is  to  some  extent  taken 
into  consideration.  Since  the  wage-level  in  general  can 
be  but  little  affected  by  the  efforts  of  individuals,  attention 
is  given  chiefly  to  obtaining  from  each  workman  the 
greatest  productivity.  To  this  end,  not  only  is  a  wage 
sufficient  for  the  support  of  the  workman  readily  agreed 
to,  but  bonuses  or  premiums  are  paid  with  a  view  to 
stimulating  the  workman  to  a  more  efficient  performance, 
within  the  limits  set  by  health,  safety  and  continued 
physical  endurance.  It  is  to  the  interest  of  the  employer 
to  keep  the  base  wage  as  low  as  possible,  in  order  to 
leave  a  broader  margin  for  use  as  incentive-wages. 

Whether  from  motives  of  altruism  or  of  business  pol- 
icy, the  intelligent  employer  desires  to  see  his  men  con- 
tented in  their  employment,  but  desires  to  retain  the  max- 
imum of  control  over  the  rates  of  wages  and  over  the 
conditions  of  employment  in  general.  This  control  is 
threatened  by  the  organization  of  trade-unions,  which 
make  powerful  collective  action  possible  to  those  who 
were  practically  helpless  as  individuals.  Whereas  the  in- 
dividual workman  was  formerly  almost  helpless  in  his 
dealings  with  the  individual  employer,  the  individual  em- 


2-8  PRINCIPLES  OF  BUSINESS 

ployer  is  now  almost  helpless  in  his  dealings  with  the 
labor-union.  It  is  but  natural  that  individual  employers, 
their  control  of  industry  menaced  by  the  rise  of  the  trade- 
unions,  should  have  devised  means  of  collective  action, 
organizing  themselves  into  "employers'  associations,"  or 
''manufacturers'  associations." 

"Strikes  are  mainly  successful  in  the  early  stages  when 
employers  have  not  learned  the  tactics  of  organization. 
After  they  have  perfected  these  associations,  after  these 
associations  have  federated,  and  especially  after  employ- 
ers have  consolidated  in  great  corporations  or  trusts,  their 
capacity  for  united  action  exceeds  that  of  organized  labor. 
Their  tactics  are  directed,  not  so  much  toward  winning 
in  strikes  as  toward  preventing  strikes  and  disintegrating 
unions.  By  wise  promotions,  by  watchful  detectives,  by 
prompt  discharge  of  agitators,  by  an  all-round  increase 
of  wages  when  agitation  is  active  on  the  outside,  by  a 
reduction  only  when  the  menace  has  passed  or  when 
work  is  slack,  by  shutting  down  a  plant  where  unionism 
is  taking  root  and  throwing  orders  to  other  plants,  by 
establishing  the  so-called  'open  shop' — these  and  other 
masterful  stratagems  set  up  a  problem  quite  different 
from  what  unionism  has  heretofore  met."  ^ 

Summing  up  what  we  may  call  the  wages  policy  of 
the  employer,  the  employer  desires  to  retain  the  fullest 
control  of  the  business  enterprise,  in  order  that  he  may 
enjoy  freedom  of  action,  freedom  to  adjust  the  organ- 
ization to  meet  prevailing  conditions,  and  freedom  to  use 
the  sums  which  he  must  pay  out  as  wages  in  such  a 
way  as  to  secure  the  greatest  returns  in  the   form  of 

^John  p..  Commons,  Labor  and  Administration,  p.  80. 


WAGES  279 

profits.  In  brief,  he  regards  wages  as  the  price  of  the 
employee's  most  profitable  services.  In  order  that  he 
may  secure  the  most  profitable  services  of  the  employee, 
he  prefers  to  pay  an  individual  wage,  based  upon  the 
employee's  individual  performance.  This  forms  the 
ground  of  his  opposition  to  labor-unions,  which  exert 
themselves  to  secure  not  an  individual-productivity  wage, 
but  the  highest  possible  class-wage. 

Wage-policies  of  the  labor-unions. — The  essential 
characteristic  of  the  wage-policy  of  the  labor-unions  is 
the  substitution  of  collective  bargaining  for  individual 
bargaining.^  The  most  unfortunate  feature  of  the  situa- 
tion created  by  the  carrying  out  of  this  policy  is  that, 
whether  or  not  the  wage  demands  of  the  unions  are 
economically  justifiable,  their  demands  can  be  made  effec- 
tive only  by  interference  with  production,  which,  as  we 
have  seen,  should  be  regarded  as  a  problem  distinct  from 
that  of  distribution.  Not  only  do  the  unions  directly 
affected  use  the  "strike"  as  a  means  of  enforcing  their 
demands,  but  the  "sympathetic  strike"  is  also  employed, 
bringing  external  pressure  to  bear  upon  the  employer 
with  whom  the  workmen  directly  affected  are  negotiating. 

So  far  as  production  is  concerned,  the  interests  of 
employer  and  employee  are  the  same.  So  far  as  distri- 
bution is  concerned,  there  are  limits  within  which  their 
interests  are  directly  opposite. 

We  should  be  slow  to  condemn  the  use  of  the  only 
weapon  the  tabor-unions  possess — the  power  to  withhold 
their  labor  until  their  terms  are  met.     At  the  same  time, 

^For  illustrations  of  union  and  non-union  collective  bargaining, 
see  the  end  of  this  chapter. 


28o  PRINCIPLES  OF  BUSINESS 

it  must  be  recognized  that  when  men  attach  themselves 
to  a  business  enterprise  there  may  be  certain  obligations 
created  which  may  not  be  disregarded  at  pleasure.  The 
emplo}er  stakes  his  capital  on  the  premise  that  the  work- 
men will  supply  labor  on  reasonable  terms.  The  pros- 
perity of  the  State  depends  upon  the  carrying  out  of  this 
tacit  agreement.  It  would  seem  that  the  whole  ques- 
tion is  one  of  the  interpretation  of  the  term  "reasonable," 
and  that  if  employer  and  employee  cannot  agree  between 
themselves  the  State  must  exercise  its  superior  power  and 
decide  the  matter.  Here,  however,  another  difficulty 
arises.  The  State,  conceivably,  may  define  the  conditions 
under  which  labor  may  be  employed,  but  we  have  not 
yet  reached  the  point  where  the  State  can  say  that  upon 
certain  terms  labor  must  be  employed.  The  employer  is 
still  left  with  the  right  to  withhold  his  capital  until  such 
time  as  he  may  feel  disposed  to  employ  labor  upon  the 
terms  defined.  It  is  true,  of  course,  that  capital  can- 
not afford  to  remain  idle,  but  still  less  can  the  laborer 
afiford  to  remain  idle — labor  is  a  commodity  the  most 
perishable  of  all. 

It  must  be  remembered,  however,  that  while  the  pub- 
lic may  be  disposed  in  general  to  side  with  labor  as 
against  capital,  the  labor-unions  do  not  represent  labor 
as  a  whole,  but  only  the  most  fortunate  classes  of  labor- 
ers. The  aggregate  membership  of  the  unions  at  present 
(1922)  is  something  over  two  millions — a  small  propor- 
tion, it  would  seem,  of  all  the  workers  of  the  country. 
The  labor-unions,  moreover,  are  fully  as  bitter  in  their 
attitude  toward  those  below  them  as  toward  those  above 
them,  although  it  is  possible  that  concessions  obtained 


WAGES  281 

by  the  unions  for  themselves  tend  to  improve  the  con- 
dition of  non-union  laborers  as  well. 

For  many  reasons,  legislation  on  labor  matters  is  of 
little  or  no  avail,  and  is  not  desired  even  by  the  labor- 
unions.  Legislation,  to  be  effective,  must  provide  alter- 
natives and  penalties  in  every  case — if  it  provides  a  min- 
imum wage,  it  must  guarantee  continuity  of  employment, 
or  the  provision  is  meaningless.  If  legislation  compels 
an  employer  to  pay  a  given  wage,  it  must  compel  the 
laborer  to  deliver  a  certain  amount  of  work — a  hopeless 
undertaking.  An  enlightened  public  opinion  may  accom- 
plish, however,  what  specific  legislation  cannot  accom- 
plish. 

Wage  and  labor  policies  of  the  public. — The  public 
has  realized  that  labor  disputes  are  wasteful  and  that  most 
of  the  burden  of  this  waste  falls  directly  on  it.  Various 
expedients  are  now  being  tried  by  the  Government  to 
eliminate  this  waste  and  it  is  likely  that  these  expedients, 
as  soon  as  they  can  be  justified  by  ample  testing,  will  be 
adopted  more  extensively  than  they  now  are.  The  Gov- 
ernment's aim  is  to  forestall  dispute  by  arbitration,  or 
where  disputes  are  precipitated,  to  furnish  the  machinery 
of  an  impartial  tribunal,  the  decisions  of  which  will  be 
accepted  by  both  sides  to  the  controversy.  The  early  ex- 
perience of  the  Railroad  Labor  Board  shows  how  diffi- 
cult the  carrying  out  of  such  a  program  is  likely  to  be. 
On  the  other  hand,  some  very  definite  accomplishments 
of  the  Court  of  Industrial  Relations  of  Kansas  show  what 
may  be  hoped  for.  During  the  first  ten  months  of  the 
existence  of  the  Court,  which  was  established  in  February, 
1920,  on  the  industrial  side  28  cases  were  actually  filed 


282  PRINCIPLES  OF  BUSI^'ESS 

during  the  period.  "Of  these,  25  were  filed  by  labor  and 
I  by  capital,  while  2  were  investigations  initiated  by  the 
court.  Of  the  25  cases  filed  by  labor,  20  received  formal 
attention  and  decision.  In  13  cases  a  wage  increase  was 
granted,  in  2  only  working  conditions  were  involved,  in  3 
wages  were  found  to  be  fair  so  that  no  increase  was 
allowed,  while  in  i  the  complaint  of  the  employees  was 
satisfied  by  the  action  of  the  employers,  the  court  simply 
approving  the  settlement  made.  The  remaining  qase  was 
merely  referee  action  on  a  collective  agreement."  ^  The 
court  also  carries  on  the  work  of  the  public  utilities  com- 
mission. 

The  extent  to  which  the  national  and  state  governments 
are  assisting  in  the  work  of  solving  labor  problems  is 
reflected  in  the  program  and  resolutions  of  the  convention 
of  the  Association  of  Governmental  Labor  Officials  of 
the  United  States  and  Canada.-  Discussions  covered  the 
use  of  labor  statistics,  vocational  education,  child  labor, 
women  in  industry,  and  methods  of  factory  inspection. 
The  following  are  some  of  the  resolutions  that  were 
adopted : 

"Resolved,  That  this  association  indorse  the  minimum 
standards  for  children  in  industry  adopted  by  the  Child 
Welfare  Conference  called  by  the  Children's  Bureau  of 
the  United  States  Department  of  Labor  in  191 9. 

"Resolved,  That  in  view  of  the  importance  of  safe- 
guarding the  health  of  working  children  through  adequate 
provision  for  physical  examination  of  minors  entering  in- 

^  Monthly  Labor  Review,  June,  1921,  p.  133. 

*  Convention  was  held  May  2  to  5,  1921,  at  the  Grunewald  Hotel 
in  New  Orleans. 


WAGES  283 

dustry  and  at  work,  this  association  expresses  its  approval 
of  the  principles  embodied  in  recommendations  of  the 
committee  appointed  by  the  United  States  Children's 
Bureau  to  formulate  standards  of  health  for  working 
children,  and  recommends  the  general  adoption  of  these 
standards  in  the  various  States  and  Provinces. 

"Resolved,  That  the  convention  recommend  that  the 
uniform  method  of  tabulation  of  accident  statistics  now  in 
use  in  several  States  be  employed  by  the  different  States 
and  Provinces,  and  that  notice  of  this  recommendation  be 
sent  to  the  boards  and  commissions  that  deal  with  indus- 
trial accidents. 

"Resolved,  That  the  association  recommend  that  more 
adequate  opportunities  for  vocational  training  in  trades 
or  industry  be  offered  to  women  and  girls,  and  that  no- 
tice of  this  recommendation  be  sent  to  the  various  State 
and  provincial  boards  of  education. 

"Resolved,  That  the  association  recommend  that  State 
labor  departments  take  a  more  active  part  in  shaping  the 
policy  of  labor  legislation  in  their  respective  States."  ^ 

Minimum  wage  legislation. — Minimum  wage  legisla- 
tion is  not  designed,  in  its  present  state  of  development,  to 
influence  the  prevailing  rates  of  ordinary  wages,  but  only 
to  protect  society  against  the  evil  effects  of  the  payment 
of  less  than  a  living  wage  to  women  and  minors.  The 
right  of  the  State  to  enact  protective  legislation  is  based 
on  the  police  power  of  the  State.  In  addition  to  minimum 
wage  laws  affecting  the  employment  of  women  and 
minors,  this  type  of  legislation  includes  the  enactment  of 
^Monthly  Labor  Rcviciv,  June,  1921,  p.  6. 


284  PRINCIPLES  OF  BUSINESS 

laws  providing  for  workmen's  compensation  for  all  in- 
dustrial accidents;  "Sunday  Closing"  Laws;  and  laws 
specifying  the  maximum  length  of  the  working  day. 

Prior  to  the  year  1918  practically  all  the  States  had 
passed  workmen's  compensation  acts,  and  thirteen  States 
had  enacted  laws  providing  a  minimum  standard  of  wages 
for  women  and  minors.  The  minimum  wage  laws  of 
three  States — Oregon,  Arkansas  and  .  Minnesota — had 
been  upheld  by  their  supreme  courts  and  the  decision  of 
the  Supreme  Court  of  Oregon,  holding  the  Oregon  law 
constitutional,  had  been  left  unchanged  by  the  equal  divi- 
sion of  the  Supreme  Court  of  the  United  States,  April 
9,  191 7,  Mr.  Justice  Brandeis  not  voting,  as  he  had  rep- 
resented the  State  of  Oregon  in  upholding  this  law  prior 
to  his  elevation  to  the  Bench. 

State  minimum  wage  laws,  as  noted  above,  are  based 
on  the  right  of  the  State,  by  the  exercise  of  its  police 
power,  "to  modify  or  restrict  the  liberty  of  contract  in 
behalf  of  the  general  welfare  as  conceived  by  the  leg- 
islature." The  Supreme  Court  held  that  "we  do  not  look 
to  the  Constitution  to  find  the  legislative  power  of  a 
State.  The  State  legislature  possesses  all  legislative 
power  not  withheld  or  forbidden  by  the  terms  of  the 
State  or  Federal  constitution." 

Two  methods  of  fixing  the  minimum  wage  are  to  be 
observed  in  the  several  laws  referred  to;  one  is  the  fix- 
ing of  a  minimum  rate  by  the  legislature — the  other,  a 
more  practicable  method,  is  the  creation  by  the  legislature 
of  a  commission  empowered  to  fix  and  adjust  a  minimum 
rate  from  time  to  time,  to  meet  changing  conditions.  The 
power  of  a  commission  to  fix  minimum  rates  was  ques- 


WAGES  285 

tioned  as  being  a  delegation  of  legislative  authority, 
which,  of  course,  would  be  unconstitutional.  As  to  this 
contention,  however,  the  court  held,  in  the  Minnesota 
Case  (Williams  YS.  Evans,  165  N.  W.,  495),  "That  there 
was  no  such  delegation,  but  only  an  authorization  to 
determine  such  facts  as  the  law  itself  requires  to  be 
decided  before  it  shall  take  effect,  saying,  'The  true  dis- 
tinction is  between  the  delegation  of  power  to  make  the 
law,  which  necessarily  involves  a  discretion  as  to  what 
it  shall  be,  and  conferring  authority  or  discretion  as  to 
its  execution,  to  be  exercised  under  and  in  pursuance 
of  the  law.  The  first  cannot  be  done;  to  the  latter  no 
vahd  objection  can  be  made.'  "^ 

Publicity  as  a  corrective  of  labor  troubles. — What- 
ever means  eventually  may  be  devised  for  the  solution  of 
the  labor  problem — for  obtaining  a  fair  distribution  along 
with  a  maximum  production — the  first  requirement  is  an 
exhaustive  compilation  of  all  relevant  facts.  The  needs  of 
the  market  must  be  ascertained,  the  needs  of  the  laborer, 
the  needs  of  the  employer,  the  costs  of  production, 
and  the  amount,  in  the  case  of  each  business  concern, 
of  the  so-called  "net  profits."  When  all  such  informa- 
tion is  secured  and  classified,  and  given  to  the  public,  it  is 
to  be  looked  for  with  confidence  that  an  enlightened  pub- 
lic opinion  will  compel  an  approximately  fair  or,  at  any 
rate,  satisfactory  settlement  of  every  point  in  dispute. 

It  is  not  very  long  since  the  idea  that  "a  public  office 
is  a  public  trust"  was  hailed  as  marking  a  new  era  in 
politics.     The  public  office  was  no  longer  to  be  regarded 

'^Monthly  Review  of  the  Bureau  of  Labor  Statistics,  March,  1918, 
p.  144. 


286  PRINCIPLES  OF  BUSINESS 

as  an  instrument  for  the  securing  of  private  gain,  but 
of  service  to  the  pubHc.  We  have  now  reached  the  point 
v^here  it  can  be  said  that  a  public  business  is  a  public 
trust;  that  the  holding  of  property  implies  not  only  the 
responsibility  of  society  in  the  protection  of  the  holder, 
but  also  the  accountability  of  the  holder  to  society.  The 
doctrine  of  the  divine  right  of  the  property-holder  seems 
in  a  fair  way  to  follow  that  of  the  divine  rights  of 
kings — not  that  there  appears  at  present  any  workable 
scheme  for  the  abolition  of  private  property  rights,  even 
if  that  were  desirable,  but  that  in  our  modern  world- 
democracy  no  privilege  is  to  be  granted  except  in  con- 
sideration of  service  to  be  received  by  the  public.  If 
the  property-holder  is  to  be  held  accountable  to  the 
public,  his  books  must  be  opened  to  the  public.  The  net 
profits  of  every  business  enterprise,  as  revealed  by  the 
tax  returns,  should  be  published,  or  at  least  made  readily 
ascertainable.  If  public  opinion  is  to  be  the  deciding 
power  in  wage  controversies,  no  relevant  facts  must  be 
withheld. 

BIBLIOGRAPHY 

Kent,  Robert  Thurston,  Wage  Systems  of  Scientific  Management. 

Hobson,  S.  G.,  Guild  Principles  in  War  and  Peace. 

Orage,  A.  R.,  National  Guilds. 

Valentine,  R.  V.,  Work  and  Pay. 

Atkinson,  Henry,  A  Rational  Wages  System. 

Schwab,  Charles  M.,  My  Twenty  Thousand  Partners. 

Thompson,  William  R.,  The  Premium  Bonus  System. 

Kleene,  Gustav  Adolph,  Profit  and  Wages. 

Gantt,  H.  L.,  Work,  Wages  and  Profit. 

Bowley,  Arthur  Lyon,  Prices  and  Earnings  in  Tim^e  of  War,  pp« 
411-442. 

National  Consumers'  League,  Minimum  Wage  or  Need  of  Hour 
and  Wage  Regulations,  1916. 

National  Civic  Federation,  The  Minimum  Wage  by  Law  (Survey 
of  Status,  1916). 


CHAPTER    XIV 

WAGE  SYSTEMS 

Wages  from  the  employer's  point  of  view. — It  has 
been  necessary  to  attempt  in  the  foregoing  chapter  a  con- 
sideration of  wages  from  several  points  of  view.  In 
this  chapter,  however,  we  must  regard  wages  primarily 
from  the  employer's  point  of  view — that  wages  are  what 
must  be  paid  in  order  to  secure  the  employee" s  most  profit- 
able services. 

Wages  analyzed. — The  payments  made  to  a  workman 
to  secure  his  most  profitable  services  will  be  seen  to  con- 
sist of  the  following  elements : 

1.  A  sum  sufficient  to  secure  the  workman's  time — 
which  will,  in  other  words,  induce  him  to  give  up  his  per- 
sonal freedom. 

2.  An  additional  amount  which  will  make  him  willing 
also  to  expend  his  physical  energy. 

3.  An  extra  amount  which  will  secure  his  careful 
thought  as  well  as  his  mere  physical  exertion. 

4.  An  amount  in  addition  to  the  foregoing  which  will 
secure  the  workman's  good-will,  so  that  he  will  bring 
to  his  task  not  only  diligence  and  intelligence,  but  also 
a  certain  elan,  in  the  spirit  of  which  he  will  feel  himself 
to  be  not  merely  an  employee  but  a  part  of  the  business 
itself. 

When  the  workman  has  given  these  he  can  give  no 
more,   and  accordingly   receives  no   further  increase  in 

287 


288  PRINCIPLES  OF  BUSINESS 

wages  for  doing  the  same  kind  of  work.  There  remains 
to  him,  however,  the  prospect  of  promotion. 

Under  certain  conditions  and  with  respect  to  certain 
kinds  of  work  the  employer  may  not  need  to  pay  for  all 
these  degrees  of  excellence  in  a  workman.  He  may  be 
able  to  dispense  with  the  clan,  which  is  far  less  valuable, 
for  example,  in  the  bookkeeping  department  than  in  the 
sales  department.  With  respect  to  certain  other  kinds 
of  work*  good-will,  and  even  intelligence  and  skill,  may 
be  classed  with  the  non-essentials.  It  may  be  cheaper  to 
secure  a  given  productivity  by  employing  a  lower  grade 
of  labor  and  resorting  somewhat  to  "driving"  methods. 
The  watchman,  for  example,  who  is  perhaps  the  lowest- 
paid  laborer,  contributes  little  more  than  his  time. 

The  value  of  the  foregoing  analysis  is  to  make  clear 
the  fact  that  wages,  from  the  standpoint  of  business,  are 
a  means  ( i )  of  purchasing  the  required  amounts  of  time, 
strength,  skill,  intelligence  and  good-will  which  may  be 
required  for  the  task  in  hand,  and  (2)  of  injecting  a 
stimulus  into  the  organization  at  points  where  it  tends  to 
lag,  where  extra  movement  is  required.  It  follows  that 
wages  cannot  be  adjusted  or  apportioned  economically 
to  the  various  requirements  unless  the  requirements  are 
known;  hence  the  importance  in  their  relation  to  wages, 
of  such  studies  of  the  work  to  be  done  as  are  possible 
under  scientific  management.  Time  and  motion  study, 
standardization,  and  other  allied  features  of  scientific 
management,  enable  the  employer  to  purchase  exactly 
the  quantity  and  quality  of  services  which  are  required 
for  the  doing  of  a  given  task.  It  may  be  said  also  that 
from  the  standpoint  of  the  workman  these  same  methods 


WAGE  SYSTEMS  289 

of  scientific  management  provide  him  with  the  means  of 
finding  the  task  to  which  he  is  suited,  and  also  with  the 
means  of  advancement  as  he  becomes  competent  to  fill 
higher  positions. 

As  business  methods  are  perfected,  guesswork  is  done 
away  with  and  accurate  knowledge  takes  its  place.  For 
example,  when  purchases  are  made^  the  goods  purchased 
must  conform  to  the  specifications,  which  specifications 
are  based  on  a  careful  study  of  the  requirements.  So  it 
is  with  the  employment  of  labor,  for  while  business  may 
not  look  upon  the  workman  himself  as  a  commodity,  it 
is  undoubtedly  true  that  his  work  is  and  must  be  regarded 
as  a  commodity.^  Any  means  by  which  this  commodity 
is  measured  and  paid  for  is  known  as  a  wage-system. 

Three  kinds  of  wages. — The  various  wage  systems 
which  business  has  evolved  may  be  grouped  under  one 
or  the  other  of  the  following  heads : 

1.  Time-wages. 

2.  Service  wages,  or  "piece-rates." 

3.  Rate-of-service  wages  or  "efficiency  wages." 

The  basis  of  the  first  is  the  time  the  workman  spends; 
of  the  second,  the  amount  of  work  he  does;  of  the  third, 
the  speed  with  which  he  performs  a  given  amount  of 
work. 

The  third   class — rate-of-service   wages — is   the   most 

satisfactory,  in  principle,  but  it  must  not  be  supposed  that 

^  Without  contending,  necessarily,  that  labor  is  a  commodity  it  is 
safe  to  assert  that  labor  is  regarded  as  if  it  were  a  commodity. 
The  Clayton  Act  states  specifically  that  labor  is  not  a  commodity. 
This  clause  was  inserted,  it  is  said,  by  Senator  Cummins,  who 
feared  that  the  courts  might  construe  labor  to  be  a  commodity 
and  restrain  combinations  of  labor,  which  was  not  the  intention  of 
the  framers  of  the  bill,  their  purpose  being  to  prevent  combina- 
tions in  restraint  of  trade,  or  commerce. 


290  PRINCIPLES  OF  BUSINESS 

it  is  practicable  for  the  average  business  to  adopt  one 
class  or  another  to  the  exclusion  of  the  other  classes. 
Even  in  the  best-managed  establishments  all  three  classes 
will  be  found. 

A  very  brief  outline  of  the  essential  characteristics  of 
the  three  types  may  be  given  here,  before  they  are  taken 
up  in  more  detail. 

Time-wages  are  based  on  the  assumption  that,  on  the 
average,  men  are  much  alike,  and  that  if  a  man's  time  can 
be  secured  his  nature  will  manifest  itself  in  a  performance 
conforming,  within  rather  wide  limits,  to  the  standards  of 
his  class. 

Service-wages,  or  piece-rates,  are  based  upon  the 
assumption  that  a  specified  amount  is  paid  for  a  specified 
service,  the  rate  being  designed  to  approximate  the  time- 
rate  for  a  similar  service,  with  a  lessening  of  the  loss 
due  to  "soldiering,"  and  a  general  relief  from  uncer- 
tainty. 

The  rate-of-service  plan  for  the  payment  of  wages, 
however,  is  the  result  of  the  recognition  of  what  we  have 
come  to  regard  as  the  scientific  principles  which  may  be 
applied  to  business  methods.  To  reduce  the  time  in 
which  a  job  is  done  is  to  increase  the  return  upon  the 
capital  invested ;  to  maintain  a  schedule  makes  team-work 
possible  and  greatly  expands  the  possibilities  of  the  work- 
ing unit — "unit"  being  taken  here  to  mean  the  assemblage 
of  men  and  machines  devoted  to  a  given  task.  Some  of 
the  l:>enefits  that  follow  the  synchronizing  of  the  working 
force  and  the  reduction  of  the  time  required  for  perform- 
ing a  task  are  seen  to  be : 

I.  Saving  in  overhead  expense 


WAGE  SYSTEMS  291 

(a)  Machine  time   (interest  and  depreciation) 

(b)  Machine   operating   expense    (power,    lubri- 

cants, engineer) 

(c)  Proportion  of  interest  and  depreciation  on 

entire  plant 

(d)  Supervision  and  overhead  management 
2.  Profits  gained 

(a)  From    increased    production    of    individual 

workman 

(b)  From  increased  production  as  a  whole,  due 

to  maintaining  of  schedules,  as  well  as 
from  strengthening  of  the  esprit  de  corps. 

Time  wages. — The  system  which  we  call  the  time- 
wage  system  includes  all  time-rates — hour,  day,  week, 
or  month. 

Certain  advantages  of  the  time-wage  are  obvious.  The 
keeping  of  accounts  is  a  very  simple  matter;  the  quality 
of  the  work  is  not  so  likely  to  suffer  as  where  the 
worker's  wages  depend  upon  the  amount  of  work  he  does ; 
there  is  perhaps  an  advantage,  from  the  social  viewpoint, 
in  the  equalizing  of  conditions  so  that  men  of  a  certain 
class  may  receive  approximately  the  same  rate  of  pay, 
even  if  by  reason  of  unequal  ability,  caused  in  part  by 
the  injustices  of  our  social  system,  or  by  other  things  for 
which  the  individual  cannot  be  held  responsible,  the  out- 
put of  the  individuals  in  the  class  is  unequal;  again,  un- 
doubtedly the  hiring  of  men  on  a  time  basis,  especially 
where  the  time  is  long,  tends  to  stabilize  labor  conditions. 

The  disadvantages  of  the  system  are  equally  obvious. 
While  there  is  a  limited  benefit  derived  from  the  equaliza- 
tion of  wages,  it  is  not  fundamentally  correct,  from  the 


292  PRINCIPLES  OF  BUSINESS 

standpoint  of  business,  to  permit  reward  except  in  pro- 
portion to  performance.  The  workman  is  tempted  to  do 
as  little  as  possible  without  running  too  great  a  risk  of 
discharge.  As  a  negro  said  in  expostulating  with  a  fel- 
low workman  for  setting  too  fast  a  pace,  "What  is  the  use 
of  rushing  through  work  just  to  get  to  work?"  There 
is  no  continuous  and  immediate  incentive  operating  to 
impel  the  workers  to  improve  their  methods  and  thereby 
to  earn  a  higher  wage;  and  if  wages  are  not  used  in  their 
function  of  stimulating  production,  they  have  lost  a  con- 
siderable portion  of  their  value.  Again,  under  the  time- 
wage  system,  there  is  no  regular  means  of  measuring 
work  so  that  the  employer  can,  with  little  extra -expense, 
.ascertain  the  times  which  make  up  his  labor  cost.  A 
further  consideration  is  that  while  the  foreman  over  day- 
laborers  may  desire  to  have  a  good  showing  made  by  his 
men,  as  a  group,  he  is  inclined  to  resent  any  noticeable 
superiority  in  an  individual;  he  may  think  the  man  is 
"after  his  job,"  and  may  even  find  a  pretext  upon  which 
to  discharge  him.  In  any  case,  the  ambitious  worker  is 
at  a  disadvantage,  because  there  is  no  way  provided 
whereby  his  work  may  come  to  the  attention  of  the  man- 
agement through  written  records.  It  may  also  be  taken 
for  granted  that  so  long  as  the  time-rate  persists,  so  long 
will  the  labor-unions  be  compelled  to  make  war  against 
capital,  since  the  time- wage  results  from  bargaining  and 
not  from  a  scientific  study  of  conditions. 

Service-wages. — Service-wages,  or  piece-rates,  are  de- 
signed to  protect  the  employer  against  "soldiering"  on 
the  part  of  the  workmen,  and  also  to  lessen  the  cost  of 
supervision.     Under  this  system,  moreover,  it  is  some- 


WAGE  SYSTEMS  293 

times  possible  to  get  work  done  more  cheaply,  since  cer- 
tain classes  of  work  can  be  done  at  irregular  times  and 
places,  even  at  the  homes  of  the  workers,  who  are  thus 
enabled  to  earn  a  regular  wage  elsewhere  and  a  piece- 
wage  at  home  in  their  "spare  time."  These  latter  con- 
siderations, however,  in  most  businesses,  are  merely  in- 
cidental, the  main  purpose  of  the  piece-rate  being  to  en- 
able the  employer  to  purchase  a  specific  service  at  a  speci- 
fied price. 

The  base  upon  which  the  service-wage  rests  is  nomi- 
nally the  prevailing  time-wage  received  by  workers  in  a 
similar  occupation.  Given  the  average  amount  of  work 
done  by  the  day  at  a  certain  wage,  the  piece-rate  is  fixed 
so  that  a  somewhat  similar  amount  of  effort  on  the  part 
of  workers  of  the  same  ability  will  be  rewarded  by 
approximately  the  same  wage. 

There  is  a  temptation,  of  course,  for  the  employer  to 
fix  the  piece-rates  on  a  basis  of  the  time  taken  by  the 
best  workmen.  In  this  case,  if  a  good  man  does  his  best, 
the  average  worker  might  not  be  able  to  earn  a  living 
wage.  The  result  is  that  when  records  are  being  made 
at  the  time  when  a  job  is  "priced,"  the  workers  take  more 
time  than  is  required,  and  the  employer,  when  he  dis-^ 
covers  the  deception,  can  scarcely  be  blamed  for  attempt- 
ing to  cut  the  rates. 

It  is  easy  to  vizualize  the  evils  that  naturally  follow 
the  establishing  of  wage  payments  upon  such  a  basis. 
Tempted  by  the  immediate  prospect  of  more  pay  for 
additional  exertion,  the  workers  will  "speed  up"  until 
they  turn  out  much  more  work  than  the  tin\e-wage 
workers,  probably  to  the  detriment  of  their  health  or  to 


294  PRINCIPLES  OF  BUSINESS 

the  sacrifice  of  their  customary  recreations.  The  em- 
ployer feels  aggrieved.  He  sees  the  workers  earning  not 
so  much  per  piece,  but  so  much  per  day.  "Five  dollars  a 
day,"  he  may  exclaim,  "that  is  more  than  I  make  myself!" 
Thereupon  he  cuts  the  rate  to  a  "reasonable"  amount. 
If  the  workers  accept  the  new  rate  they  must  work  harder 
than  they  did  when  they  were  receiving  a  time-wage,  in 
order  to  earn  the  same  amount  of  money. 

In  view  of  the  manifest  injustice  of  such  a  situation, 
it  is  certain  that  retaliation  in  some  form  on  the  part  of 
the  employees  may  be  expected.  One  form  which  this 
retaliation  is  sure  to  take  is  the  doing  of  slovenly  work 
wherever  there  is  a  chance  of  its  not  being  discovered  by 
the  inspector.  Machinery  and  equipment  are  likely  to 
be  carelessly  used,  if  not  intentionally  abused.  Schemes 
will  be  evolved  for  "beating  the  management."  Perhaps 
by  common  consent  the  workers  will  limit  their  produc- 
tion to  a  point  far  below  that  of  their  normal  capacity; 
hopeless  of  obtaining  a  consistent  high  money-wage  they 
will  supplement  their  money-wage  with  as  much  ease  or 
personal  comfort  as  they  can  obtain,  at  the  expense  of 
their  employer,  who  in  order  to  retain  his  employees  is 
forced  to  pay  a  rate  per  piece  considerably  higher  than 
would  be  necessary  if  the  employees  were  able  to  exert 
themselves  without  incurring  the  danger  of  Tiaving  the 
rates  cut  again. 

Another  source  of  disturbance  is  that  rates  often  vary 
in  different  establishments  in  the  same  community,  or 
even  in  different  departments  of  the  same  establishment. 

It  is  not  intended  that  the  conditions  pictured  above 
shall  be  taken  as  usual  or  typical  in  a  business  where  serv- 


WAGE  SYSTEMS  295 

ice-wages  are  paid.  Although  the  danger  of  their  occur- 
rence is  nearly  always  present^  such  difficulties  may  not 
materialize  in  a  well-ordered  business,  where  the  spirit 
of  the  "square  deal"  prevails  both  in  the  management  and 
among  the  men.  In  such  a  business,  the  payment  of 
service-wages,  in  cases  where  rate-of-service  wages  could 
be  substituted,  does  imply,  however,  a  failure  to  recognize 
the  facts  that  service  consists  not  merely  in  delivering  a 
certain  total  amount  of  performance,  but  in  delivering  it 
within  a  certain  time;  and  that  all  the  elements  of  service 
should  be  standardized — the  time  element  as  well  as  the 
quantity  and  quality  elements.  The  simplest  illustration 
will  show  that  this  is  true.  The  locomotive  engineer  is 
paid  to  run  his  engine  and  its  train  of  cars  not  only  over 
the  number  of  miles  of  track  of  which  his  "division" 
consists,  but  also  to  do  this  in  a  specified  time.  He  can- 
not come  in  an  hour  late  and  say  "Here  are  your  engine 
and  cars."  He  has  disarranged  the  schedule,  kept  other 
trains  waiting  and  done  more  injury  to  the  system  than 
the  value  of  his  wages  could  offset.  So  in  a  shop,  with  its 
machines  and  processes  co-ordinated  by  the  planning  de- 
partment and  run  on  a  schedule,  the  time  element  in 
service  is  often  as  important  as  the  quantify  element. 

Ha  business  were  completely  standardized  and  if  the 
work  were  done  always  in  standard  time,  there  would  be 
only  one  system  of  wage-payments,  by  whatever  name 
the  system  might  be  called.  If  the  schedule  were  main- 
tained, what  would  it  matter  whether  the  engineer  got 
$150  a  month  and  made  30  trips,  or  made  30  trips  a 
month,  at  $5  each  ? 

The  sliding  scale. — The  sliding  scale  is  a  piece  or 


296  PRINCIPLES  OF  BUSINESS 

"service"  wage  (used  principally  in  the  iron  and  steel 
industries)  designed  to  adjust  itself  automatically  to 
varying  conditions  of  business  prosperity,  the  selling  price 
of  the  product  being  taken  as  the  index  of  prosperity  dur- 
ing the  period  in  question. 

A  base  or  minimum  rate  for  boiling  a  ton  of  pig  iron, 
for  example,  is  agreed  upon,  to  apply  when  bar  iron  is 
selling  at  a  given  price,  or  less,  per  pound;  if  the  price 
falls  below  the  base  price  the  wage  remains  the  same; 
if  the  price  rises,  however,  the  wage  is  increased  suffi- 
ciently to  give  the  laborer  a  percentage  of  increase  in 
wages  amounting  to  about  one-half  the  percentage  of  in- 
crease in  price  of  the  product. 

The  scale  is  revised  annually,  and  at  intervals — usually 
of  two  months — the  management  issues  to  the  representa- 
,tives  of  the  workmen  a  sworn  statement  of  the  prices  ob- 
tained for  the  product  during  the  preceding  two  months, 
from  which  prices  are  computed  the  amounts  the  work- 
men have  earned  above  the  minimum,  or  base,  rate. 

The  sliding-scale  system  has  some  advantages,  arnong 
them  being  its  stabilizing  effect  upon  the  relations  between 
the  workmen  and  their  employers;  some  of  the  uncer- 
tainty as  to  future  wages,  from  the  workman's  point  of 
view,  and  as  to  labor  cost,  from  the  employer's  point  of 
view,  is  eliminated,  and  a  partial  profit-sharing  feature  is 
introduced.  It  is  easily  seen,  however,  that  such  a  system 
would  be  applicable  only  in  a  very  narrow  field,  where 
conditions  generally  are  somewhat  standardized,  and 
where  the  labor  cost  is  the  largest  part  of  the  total  pro- 
duction cost  which  is  liable  to  fluctuation.  Where  the 
increase  over  the  base  rate  is  proportionate  only  to  the 


WAGE  SYSTEMS  297 

selling  price  and  not  also  to  the  production  cost,  a  rise  in 
prices  of  raw  materials  or  other  supplies  might  more 
than  offset  the  benefit  of  an  increase  in  selling  price,  and 
work  an  injustice  to  the  employer — assuming  that  the 
base  rate  had  been  established  with  justice  to  each  of  the 
parties  to  the  contract. 

Rate-of-service  wages. — The  several  wage-systems 
which  we  shall  consider  under  the  classification  "rate-of- 
service  wages"  recognizes  to  a  greater  or  less  degree  the 
time  element  as  well  as  the  quantity  and  quality  elements, 
and  their  development  is  to  be  taken  as  part  of  the  move- 
ment toward  standardization.  The  important  wage-sys- 
tems which  include  rate  of  service  as  an  element  in  the 
determining  of  the  total  wage  are  : 

1.  The  Halsey  system. 

2.  The  Rowan  system  (British). 

3.  The  Taylor  differential  piece-rate. 

4.  The  Gantt  "task  and  bonus"  system. 

5.  The  Emerson  "efificiency"  system. 

6.  The  Ford  system. 

In  each  of  these  "rate-of-service"  systems,  increased 
performance  is  rewarded  by  the  giving  of  a  bonus.  In 
the  Halsey  and  Rowan  systems  this  bonus  is  not  standard- 
ized; the  more  scientific  systems  of  Taylor,  Gantt,  and 
Emerson,  however,  are  characterized,  as  might  have  been 
expected,  by  a  standardized  bonus.  The  Ford  system, 
while  providing  the  same  rate  of  pay  to  all  workers  in  a 
class,  is  in  reality  a  rate-of-service  wage,  because  working 
methods  are  so  standardized  that  the  output  of  the  work- 
man is  practically  determined  for  him  by  the  manage- 
ment; if  he  does  not  maintain  the  schedule  he  is  trans- 


298  PRINCIPLES  OF  BUSINESS 

ferred  to  a  position  which  he  is  able  to  fill,  or  as  a  last 
resort,  is  discharged. 

The  Halsey  System/ — The  Halsey  system  of  wage 
payment  is  a  gain-sharing  plan.^  It  is  to  be  dis- 
tinguished from  the  "scientific  management"  plans  in 
that  there  is  no  preliminary  time  and  motion  study 
employed  in  determining  the  so-called  standard  time  for 
the  doing  of  any  work.  The  best  time  made  by  the 
average  workman  is  taken  as  a  basis,  this  time  being 
ascertained  from  the  records.  A  time-rate  is  paid  for 
the  maintaining  of  this  average  time,  with  an  increase  for 
piece-work  finished  in  less  than  the  standard  time,  the 
workman  getting  credit,  however,  for  only  half  or  a  third 
of  the  time  he  saves. 

This  system  has  been  widely  adopted  and  has  in  many 
cases  been  productive  of  excellent  results.  The  reason 
for  its  success  has  apparently  been  the  ease  with  which 
it  can  be  installed  without  interfering  with  established 
methods  of  work.  In  this  respect  it  stands  in  contrast 
to  the  superior  and  more  scientific  systems  which  can  be 
installed  only  after  a  thorough  overhauling  of  the  whole 
establishment — an  overhauling  that  frequently  arouses 
the  antagonism  of  the  men. 

Since  the  time  standards  of  the  Halsey  system  are  not 
ascertained  by  means  of  a  careful  study  of  methods,  the 
workman  is  often  able  to  reduce  the  average  time  to  a 

1  The  Towne  system,  which  is  not  included  in  the  hst  above,  is 
quite  similar  in  principle  to  the  Halsey  system,  the  chief  difference 
being  that  the  Towne  system  rewards  group  efficiency,  whereas  the 
Halsey  system  rewards  individual  efficiency. 

-  Gain-sharing,  which  is  not  to  be  confused  with  profit-sharing, 
means  adding  to  the  workman's  wages  a  part  of  the  saving  due  to 
an  increase  in  the  speed  of  his  work. 


WAGE  SYSTEMS  299 

startling  extent,  whereupon  there  is  a  temptation  for  the 
management  to  cut  the  time  to  a  more  reasonable  one, 
which  again  brings  up  one  of  the  fundamental  weak- 
nesses of  the  old  piece-rate  system,  the  fear  on  the  part 
of  the  workman  that  if  he  exerts  himself  to  earn  more, 
the  rate  will  be  cut  so  that  he  will  thereafter  be  compelled 
to  work  harder  in  order  to  earn  only  as  much  as  he  was 
earning  before. 

It  has  been  recognized,  therefore,  in  all  the  modern 
systems,  that  there  must  be  no  cutting  of  a  rate  once  set, 
unless  the  reduction  is  clearly  justified  by  the  introduc- 
tion of  improved  machinery  or  by  a  marked  change  in  in- 
dustrial conditions  generally. 

Under  the  Halsey  plan  there  is  a  chance  for  the  men 
to  "beat  the  management"  when  a  new  piece  of  work 
comes  into  the  shop  and  a  standard  time  has  to  be  set  for 
it.  The  men  will  "soldier"  on  the  job — that  is,  purposely 
take  longer  to  do'  it  than  is  necessary.  The  time  being 
set  from  the  low  records  they  have  made,  they  will  be 
able  afterward  to  do  the  same  work  in  perhaps  half  the 
time  and  earn  a  large  premium. 

The  Rowan  plan. — The  Rowan  (a  British)  system 
is  similar  in  effect  to  the  Halsey  plan,  but  differs  in  the 
way  in  which  the  premium  for  better  performance  is  com- 
puted; also  in  the  relative  increase  of  the  premium  for 
extra  performance.  In  the  Rowan  system,  the  guaran- 
teed time-rate,  as  in  the  Halsey  system,  is  based  on  past 
average  performance.  Instead,  however,  of  returning 
to  the  workman  a  premium  amounting  to  the  regular  rate 
of  pay  for  a  percentage  of  the  time  saved,  usually  a  half 
or  a  third,  the  Rowan  plan  returns  a  percentage  of  the 


300  PRINCIPLES  OF  BUSINESS 

standard  time-rate  for  the  time  used;  the  amount  the 
workman  receives  as  a  premium  is  found  by  ascertaining 
the  percentage  of  time  saved  and  letting  the  bonus  corre- 
spond to  this  percentage  of  the  time  actually  used.  Thus  if 
a  workman  is  employed  at  a  standard  day-rate  of  $2.70 
for  nine  hours,  or  thirty  cents  an  hour,  and  does  a  six- 
hour  standard  job  in  four  hours,  he  gets,  first,  the  regular 
pay  for  four  hours  at  30  cents  an  hour,  or  $1.20.  Having 
saved  two  hours  out'  of  the  six,  or  33  1-3  per  cent,  his 
bonus  amounts  to  a  third  of  the  regular  pay  for  the  time 
used,  or  40  cents,  making  a  total  of  $1.60  for  the  four 
hours.  A  more  simple  statement  is  that  under  the 
Rowan  plan  the  workman  gets  a  bonus  of  10  per  cent 
of  his  base  wage  for  each  10  per  cent  by  which  he  reduces 
the  time  taken  for  the  job,  as  compared  with  the  time 
set  as  the  standard.  Under  the  Halsey  plan,  having 
saved  two  hours,  worth  60  cents,  his  bonus  would  have 
been  either  one-half  or  one-third  of  this  amount. 

It  will  be  observed  that  neither  in  the  Halsey  plan  nor 
in  the  Rowan  plan  is  it  possible  for  the  workman  to  earn 
a  wage  which  could  be  considered  excessive  if  the  time 
or  base  rate  has  been  figured  reasonably.  In  the  Halsey 
plan,  each  saving  for  the  workman  means  an  equal  or 
a  greater  saving  for  the  employer.  In  the  Rowan  plan, 
as  the  percentage  increases,  the  base  rate  decreases,  so 
that  in  no  case  is  it  possible  for  the  workman  to  earn  more 
than  double  the  time-rate ;  even  to  earn  twice  the  time- 
rate  is  possible  only  theoretically,  for  to  do  so  would 
mean  a  saving  of  100  per  cent  in  the  time.  The  premium 
actually  decreases  after  a  certain  percentage  of  saving  is 
effected,  so  that  there  is  little  if  anv  incentive  to  the  most 


WAGE  SYSTEMS  301 

efficient  performance.  The  Halsey  and  the  Rowan  sys- 
tems, then,  have  two  fundamental  defects:  i.  The  base 
rate  is  not  determined  by  careful  methods,  2.  The  rate  of 
reward  decreases  as  performance  increases. 

The  Taylor  differential  piece-rate. — The  Taylor 
differential  piece-rate  is  not  to  be  looked  upon  as  a  wage- 
system  complete  in  itself,  but  as  one  to  be  used  only  in 
connection  with  the  policies  and  methods  of  scientific 
management,  as  developed  by  Mr.  Taylor  and  his  associ- 
ates.^ 

Under  the  older  wage-systems,  it  is  evident  that  there 
is  a  constant  jealousy  between  the  employer  and  the  em- 
ployees over  what  Mr.  Taylor  calls  the  division  of  the 
"surplus.''^  This  surplus  is  the  amount  of  the  selling 
price  less  production  costs,  and  the  division  of  it  has  been 
the  source  of  almost  all  the  trouble  between  capital  and 
labor.  Mr.  Taylor's  hope  was  to  make  this  surplus  so 
large  that  there  would  be  enough  for  each.  In  order  to 
produce  or  create  such  an  ample  surplus,  he  says,  it  is 
necessary  for  the  most  economical  methods  of  production 
to  be  installed,  which  methods  can  be  ascertained  only  by 
scientific  time  and  motion  study.  There  must  be  a  selec- 
tion and  subsequent  training  of  the  right  man  for  each 
task,  and  the  co-operation  of  the  workmen  with  the  man- 
agement, in  order  to  make  production  as  high  as  possible. 
It  is  apparent  that  Mr.  Taylor  either  regarded  as  hope- 
less or  else  regarded  as  unimportant  the  very  complicated 
problem  of  determining  a  ratio  of  distribution  that  would 

1  "A  Piece-Rate  System,"  Trans,  of  Amcr.  Soc.  of  Mcch.  Eng., 
Vol.   16,  p.  856. 

-Hearings  Before  Special  Committee  of  the  House  of  Represen- 
tatives to  Investigate  the  Taylor  and  Otiier  Systems  of  Shop  Man- 
agement, p.  1388. 


302  PRINCIPLES  OF  BUSINESS 

conform  to  justice  in  the  abstract,  but  fixed  the  rate  at 
the  point  where  the  wage  would  be  sufficient  to  stimulate 
the  men  to  the  degree  of  efficiency  in  production  which 
would  be  most  profitable  to  the  employer  without  injury 
to  the  health  of  the  workman. 

The  differential  piece-rate  system  devised  by  Mr.  Tay- 
lor eliminates  the  danger  that  the  men  will  try  to  "beat 
the  management"  as  they  may  do  under  the  Halsey  sys- 
tem. It  is  impossible  for  them  to  do  so,  because  tlie  rates 
have  been  set  scientifically  and  not  by  guesswork.  Two 
rates  are  paid  per  piece — one  rate  applying  to  fast  work, 
performed  according  to  the  "schedule"'  or  standard,  and 
the  other  to  slow  or  imperfect  work.  The  two  rates  are  so 
far  apart  that  the  inefficient  workman  receives  no  more 
than  ordinary  time-wages,  and  may  receive  less,  while  the 
successful  workman  receives  much  more  than  ordinary 
wages.  A  feature  of  great  importance  in  connection 
with  the  system  invented  by  Mr.  Taylor  is  that  the  "ele- 
mentary unit  times"  are  on  file  and  are  used  in  construct- 
ing the  time  allotted  for  new  work,  so  that  an  accurate 
estimate  of  labor  cost  can  be  made  in  advance.  The  rate- 
fixing  department  was  regarded  by  Mr.  Taylor  as  being 
of  much  greater  importance  than  the  differential  rate  it- 
self. 

A  most  interesting  example  of  the  Taylor  differential 
piece-rate  system,  as  developed  and  applied  by  Mr.  George 
D.  Babcock,  Manager  of  the  Franklin  Motors  Company, 
is  given  herewith,  taken  from  Mr.  Babcock's  book  The 
Taylor  System  in  Franklin  Management}  The  funda- 
mental base-rates,  it  is  explained  by  Mr.  Babcock,  have 

"'  """••'^li'^licd   by    The  Engineering   Magazine,    1918. 


WAGE  SYSTEMS  303 

been  temporarily  taken  as  the  prevailing  wage  rates  for 
men  who  worked  by  the  hour  without  task  in  the  year 
1905.  No  attempt  has  been  made  as  yet  to  determine 
the  correct  wage-rate  for  the  workers  or  in  any  way  to 
establish  fundamental  values  for  their  efforts,  but  this 
fact  has  been  established :  if  the  base  wage-rates  of  1905 
were  then  equitable,  these  base  wage-rates  are  now  equi- 
table. Here  follows  the  general  equation  for  the  basic 
rate,  where  the  premium  method  of  payment  is  used: 

and  the  equation  for  the  determination  of  labor  and  in- 
direct cost  (not  including  materials)  is: 
X=(r(i+e)+R)t. 
The  terms  used  above,  which  are  common  in  both  of 

the  following  equations,  are  defined  as  follows : 

r=Base  hourly  rate  man  is  to  receive 
K=A  constant,  when  V  is  100  per  cent,  to  bring  worker  under 

standard  conditions  to  standard  rate 
B=Fundamental  base-rate,  temporarily  that  of  1905 
i=^Percentage  of  increase  in  living  since  1905,  taken  on  the  15th 
of  January,  April,  July  and  October  of  each  year 
m=Percentage  allowed  for  each  extra  process  known  or  learned 
n=Percentage  allowed  for  years  of  connected  service 
y=Years  of  such  service 

R=Fixed  charges  rate  per  hour  which  man  has  chance  to  modify 
e=Percentage  of  premium  earned  on  time  allowance 
V^IOO,  which  is  the  standard  accomplishment  per  cent 
E=Standard  premium  task  time  set 
Pa=Percentage  of  time  absent  or  late 
S=^Value  of  spoiled  work  per  producing  hours  worked 
Pt=Percentage  of  time  under  task 

Pd=Percentage  of  time  spent  on  non-task  or  straight  time  work 
C=Co-operation  and  conduct 
X=Labor  and  fixed  charge  cost 
t=Time  taken  to  do  work 

These  terms  are  treated  at  length  in  the  book  from 
which  they  are  taken ;  in  these  pages  we  can  note  the  ex- 
planajiorv;  uf  only  a  few  of  the  more  important  of  them. 


304  PRINCIPLES  OF  BUSINESS 

With  respect  to  "R,"  in  the  equation,  the  fixed  charges 
do  not  mean  the  conventional  "overhead,"  but  only  such 
fixed  charges  as  the  workman  can  influence.  Space,  heat, 
light,  sanitation,  machine  interest  and  depreciation 
charges,  and  service  provided  for  the  worker  and  his 
machine,  will  vary  from  a  fraction  of  a  dollar  to  several 
dollars  per  hour;  the  hourly  fixed-charge  of  a  small  drill 
is  insignificant  compared  to  that  of  a  large  stamping 
press,  or  milling  machine,  or  planer.  The  rate  is  set  by 
the  management,  which  assumes  full  responsibility  for  its 
correctness;  if  the  workman  is  able  to  lessen  the  time  of 
the  operation,  he  receives  all  the  saving;  conversely,  if 
he  lengthens  the  time  of  the  operation,  an  adjustment  in 
his  rate  is  made  in  order  to  offset  the  loss  which  he  there- 
by causes  to  the  management. 

In  the  cases  of  "Pa,"  the  schedule  being  closely  fitted 
and  the  equipment  being  adjusted  to  exact  needs,  absence 
of  the  worker  causes  a  corresponding  overtime  effort 
either  by  the  same  worker  or  a  substitute,  and  since  over- 
time is  paid  at  a  one-third  higher  rate,  it  is  thought  only 
fair  that  any  conduct  of  the  worker  which  will  give  rise 
to  overtime  should  be  adjusted  by  his  rating. 

With  respect  to  "S,"  only  such  spoilage  as  the  work- 
man is  responsible  for  is  considered  in  the  adjustment  of 
the  rating.  The  problem  of  correction  for  work  spoiled 
is  a  very  difficult  one.  Although  the  workman  may 
spoil  not  only  valuable  material,  but  also  all  labor  and 
fixed  charges  previously  accumulated  on  the  part,  he  can- 
not be  held  accountable  except  for  the  moneys  paid  to  him 
and  for  the  fixed  charges  on  his  own  operation,  there  be- 
ing no  justice  in  charging  him  with  the  full  material  value 


WAGE  SYSTEMS  305 

or  previous  effort  applied,  for  which  he  is  not  account- 
able. 

Mr.  Babcock  in  commenting  upon  the  results  of  the  rat- 
ing system  here  described,  says :  "This  may  all  seem  to 
be  a  very  complex  solution  of  the  problem,  but  it  seems 
to  be  the  least  complicated  expression  which  will  solve 
the  problem  in  anj'  satisfactory  way  and  allow  for  the 
perpetuation  of  standard  rules  without  personal  differ- 
ences interfering  in  each  new  rating.  A  re-rating  occurs 
four  times  a  year.  We  feel  that  the  plan  has  been  vigor- 
ously tested.  Not  only  have  we  had  no  resignations  on 
this  account,  but  we  have  also  attracted  a  considerable 
number  of  excellent  men  to  our  force."  ^ 

The  Gantt  "task  and  bonus  system." — The  task  and 
bonus  system  was  originated  by  Mr.  H.  L.  Gantt  in  1901, 
while  he  was  associated  with  Mr.  Taylor  at  the  Beth- 
lehem Steel  Company's  plant.  It  was  at  first  a  bonus  of 
50  cents  a  day  paid  to  the  workman  who  completed  his 
tasks  within  the  time  specified  on  the  instruction  card, 
and  was  designed  to  offer  an  inducement  pending  the 
time  when  sufficient  data  could  be  accumulated  for  the 
establishing  of  the  permanent  and  inflexible  Taylor  differ- 
ential piece-rates.  The  system  was  developed  by  Mr. 
Gantt  until  it  assumed  the  form  of  a  time-rate  with  a 
substantial  bonus  for  completing  the  task  in  the  standard 
time,  or  in  less  than  the  standard  time.  This  bonus  is  a 
time-rate  for  an  agreed  percentage  of  the  standard  time, 
ranging  from  20  to  50  per  cent.  It  is  not  unlike  the 
Halsey  system,  except  in  that  the  workman  must  reach 
the  standard  before  he  receives  any  bonus,  and  in  that 

^Taylor  System  in  Franklin  Management,  p.  105. 


3o6  PRINCIPLES  OF  BUSINESS 

the  standard  time  is  calculated  scientifically.  A  bonus 
is  also  paid  to  bosses  or  foremen,  based  on  the  perform- 
ance of  the  men  under  them. 

The  Emerson  "efficiency"  system. — The  Emerson 
"efficiency"  system  is  a  compromise  between  ordinary 
methods  and  the  scientific  management  methods.  A  task 
is  set,  partly  from  workmen's  former  records  and  partly 
from  careful  estimates  of  the  proper  time-allowance,  and 
this  time  is  called  "standard."  The  workman  receives  a 
time-rate,  as  in  the  Halsey  and  Gantt  systems,  and  also 
a  bonus,  beginning  when  he  has  reached  a  point  of  effi- 
ciency of  67  per  cent  of  the  standard.  The  bonus  is, 
however,  very  small  at  this  point,  and  increases  slowly 
until  the  performance  is  within  90  per  cent  of  the  stand- 
ard, at  which  time  it  amounts  to  a  10  per  cent  increase  in 
total  wages.  At  100  per  cent  efficiency  the  bonus  is  20 
per  cent,  while  efficiency  of  more  than  100  per  cent,  which 
is  quite  possible,  on  account  of  the  moderate  standard 
requirements,  entitles  the  workman  to  the  regular  rate 
for  all  the  time  he  saves,  and  the  20  per  cent  bonus  as 
well.  The  Emerson  bonus  is  not  paid  for  each  task  by 
itself,  as  is  the  Gantt  bonus,  but  is  averaged  for  certain 
periods,  usually  of  a  month  at  a  time.  It  is  therefore  im- 
possible for  the  workman  to  exert  himself  to.  earn  a  bonus 
on  one  job  and  "loaf"  on  the  next,  without  sacrificing  a 
part  of  what  he  has  gained.  A  bonus  for  continued 
efficiency  is  also  given  by  the  Gantt  plan. 

The  Ford  system. — Like  the  Ford  car,  the  Ford  wage 
system  is  of  a  startling  simplicity.  Essentially,  it  consists 
merely  of  a  50  per  cent  increase  above  the  prevailing 
time-rates,  paid  equally  to  all  workers  of  each  class.     The 


WAGE  SYSTEMS  307 

ultimate  penalty  for  inefficiency  is  not  lower  wages,  but 
dismissal.  The  result  is  that  the  Ford  Company  prac- 
tically has  its  choice  of  the  most  desirable  workers  in  the 
entire  country.  By  means  of  a  judicious  selection  from 
the  mass  of  applicants,  men  are  secured  who  are  able  and 
willing  to  fit  themselves  into  the  Ford  organization ;  their 
ability  is  established  and  unquestionable ;  all  that  remains 
to  make  the  plan  complete  is  the  maintaining  of  the  essen- 
tial scientifically  arranged  working-methods,  so  that  the 
skill  and  willingness  of  these  superior  workmen  can  be 
utilized  to  the  fullest.  It  is  well  known  that  the  Ford 
shops  represent  the  utmost  in  scientific  management,  with 
all  that  scientific  management  implies.  The  success  of 
the  Ford  wage-system,  for  the  Ford  Company,  was  inevi- 
table. 

It  is  evident,  however,  that  a  system  W'hich  depends 
for  its  success  primarily  upon  the  attracting  of  the  better 
grades  of  workmen  can  be  successful  only  for  a  limited 
number  of  establishments.  When  the  best  workmen  are 
collected  under  the  lure  of  high  wages,  the  places  which 
they  have  left  must  suffer.  If  these  businesses  in  turn 
should  attempt  to  recall  their  workmen  by  offering  a 
similar  wage,  the  "system"  would  turn  into  a  chaos  of 
uncertainty  and  confusion.  High  wages  would  no  longer 
be  an  incentive  to  full  performance;  the  penalty  of  dis- 
charge would  lose  its  effectiveness.  One  of  the  essential 
features  of  the  sound  wage-system,  as  insisted  upon  by 
the  far-seeing  founder  of  scientific  wage-systems,  F.  W. 
Taylor,  would  be  lost — the  rewarding  of  efficiency  and 
the  penalizing  of  inefficiency. 

Essentials  of  a  sound  wage-systerri. — In  order  that 


3o8  PRINCIPLES  OF  BUSINESS 

a  wage-system  may  be  of  general  application  and  as  free 
as  possible  from  weaknesses,  or  whatever  might  make 
for  disintegration  of  the  system,  it  may  be  taken  as  estab- 
lished that  the  following  principles  or  practices  must  be 
incorporated  in  it : 

1.  The  task  upon  which  payment  is  based  must  be  the 
result  of  careful  study — preferably,  scientific  study,  of 
laboratory  accuracy.  However  intelligent  and  however 
conscientious  a  workman  may  be,  it  is  impossible  for  him 
to  develop  the  best  methods  of  working.  Instinct  will 
not  avail ;  reason  and  judgment  cannot  even  approximate 
perfection.  To  construct  even  the  simplest  scientific  task, 
it  is  necessary  to  use  laboratory  equipment  and  methods, 
with  the  aid,  when  required,  of  engineers,  or  physicians, 
or  psychologists. 

2.  Employees  must  be  fitted  to  their  respective  tasks, 
which  tasks,  of  course,  have  been  constructed  with  a  view 
to  their  performance  by  the  best-fitted  available  em- 
ployees. Means  must  be  provided  for  the  instruction 
of  the  workman  in  the  performance  of  the  task. 

3.  Employees  must  have  working  conditions  and  wages 
with  which  they  will  be  contented.  A  base  rate,  sufBcient 
to  maintain  the  employees  in  reasonable  comfort,  must  be 
guaranteed,  regardless  of  the  bonus  which  may  be  made 
by  extra  exertion.  As  a  starting-point,  in  the  fixing  of 
rates  tor  the  various  classes  of  employees,  the  prevailing 
rate  for  unskilled  labor  may  be  taken ;  the  rates  for  higher 
grades  of  labor  should  represent  approximately  the  un- 
skilled-labor wage  plus  the  cost  of  training  the  unskilled 
employee  for  the  higher  position.  Where  union  labor  is 
employed  the  union  should  employ  regularly  a  competent 


WAGE  SYSTEMS  309 

time-study  engineer,  who  may  inspect  the  conditions  of 
employment  and  report  upon  their  fairness.  Many  mis- 
understandings between  the  labor-unions  and  the  man- 
agement are  due  to  the  fact  that  the  unions  do  not  have 
full  and  accurate  information  as  to  the  actual  conditions. 

4.  There  must  be  a  certainty  that  rates  will  not  be  cut, 
once  they  are  established  on  a  scientific  basis,  unless  there 
is  a  fundamental  change  in  conditions.  With  such  an 
assurance,  the  employees  may  freely  exert  themselves  to 
earn  the  highest  bonuses  possible.  Accurate  preliminary 
time-study  is  the  best  safeguard  against  rate-cutting. 
Incidentally,  time  study  must  not  be  used  to  speed  up 
those  employees  who  are  on  a  time-wage  basis — condi- 
tions are  so  variable  that  only  unfairness  and  dissatisfac- 
tion can  result. 

5.  Efficiency  must  be  recognized  and  rewarded,  and 
inefficiency  penalized.  It  has  been  found  that  the  incen- 
tive necessary  to  induce  workmen  to  reach  the  standard 
of  performance  is  a  bonus  of  not  less  than  25  per  cent 
of  the  guaranteed  base  rate,  increasing  to  nearly  100  per 
cent  in  certain  classes  of  work.  Of  course,  the  bonus 
serves  the  double  purpose  mentioned  above ;  securing  it  is 
a  reward,  failing  to  secure  it  brings  its  own  penalty. 

The  standard  time  is  not  the  fastest  possible  time,  but 
the  time  determined  as  being  the  fastest  which  the  normal 
workman  (selected,  however,  for  his  fitness)  can  main- 
tain consistently  without  injury  to  his  health  and  without 
undue  discomfort.  The  standard  time  is  arrived  at  in 
this  way:  a  time  study  is  made;  the  best  method  is 
worked  out;  and  the  fastest  possible  time  w^hich  can  be 
made  by  an  average  workman  is  ascertained.     To  this 


3IO  PRINCIPLES  OF  BUSINESS 

fastest  time  an  "allowance"  is  added,  varying  with  the 
nature  of  the  task.  In  machine  tasks,  of  course,  the 
allowance  may  be  far  less  than  when  a  considerable 
amount  of  human  effort  is  involved.  When  the  manage- 
ment accordingly  insists  upon  the  performance  of  the 
task  in  standard  time,  the  charge  of  cruelty  would  seem 
to  be  an  unfair  one;  due  allowance  is  made  for  contin- 
gencies, and  the  task  is  not  one  that  calls  for  exertion 
beyond  the  workman's  normal  capabilities. 

The  charge  is  often  made  that  the  monotony  of  a  rou- 
tine task  is  injurious  to  the  worker.  This  does  not  seem 
to  be  substantiated  by  the  investigations  made  by  psy- 
chologists. The  monotony,  so-called,  is  not  so  much  in 
the  task  as  in  the  mind  of  the  worker.  Tasks  which 
would  seem  to  be  monotonous  are  probably  so  in  many 
cases  because  the  wage  is  insufficient.  When  the  wage 
is  raised  to  the  point  of  the  worker's  contentment  the 
"monotony"  disappears. 

The  employer  who  fails  to  make  use  of  a  wage-system 
in  which  wages  can  be  used  as  a  stimulus  to  the  organiza- 
tion, as  well  as  merely  the  means  of  securing  the  attend- 
ance of  tlie  workman,  is  overlooking  one  of  the  most 
valuable  functions  of  wages. 

CLASSIFICATION  OF  EMPLOYEES 

Necessity  for  standardization  and  classification  of 
jobs. — The  installing  of  a  scientific  system  of  wage  pay- 
ment requires,  of  course,  the  analysis  and  standardization 
of  the  various  occupations.  This  being  done,  the  rates 
may  be  applied.  With  standardization,  classification  also 
becomes  necessary,  each  task  being  designated  by  a  num- 


WAGE  SYSTEMS  311 

ber  or  symbol,  and  the  employees  being  grouped  in  classes 
according  to  the  tasks  they  perform.  For  the  stabilizing 
of  labor  conditions,  it  is  highly  desirable  not  only  that 
such  a  standardization  be  effected  within  the  single  estab- 
lishment, but  also  that  the  various  enterprises  of  a  similar 
character  within  a  district  co-operate  in  bringing  about  an 
approximate  uniformity  of  practice,  both  as  to  classifica- 
tion and  as  to  rate  of  pay  for  each  standard  occupation. 
Not  only  would  production  be  facilitated  but  the  shifting 
of  workmen  from  one  plant  to  another  by  reason  of  varia- 
tions in  wages  and  other  working  conditions  would  be 
done  away  with. 

The  Westinghouse  classification  system. — A  system 
of  classification,  worked  out  and  put  into  practice  by  the 
Westinghouse  Electric  and  Manufacturing  Company  of 
Pittsburgh,  is  described  by  Mr.  W.  S.  Stearns,  Secretary 
of  the  Occupations  and  Rates  Committee  of  the  Com- 
pany.^ 

The  Westinghouse  Company  employs  20,000  opera* 
lives.  The  plant  has  16  departments,  each  department 
being  practically  a  separate  factory,  with  its  own  superin- 
tendent and  foremen.  All  these  superintendents  report 
to  the  general  superintendent.  Many  departments  have 
occupations  alike  or  similar.  In  order  to  discourage  the 
shifting  of  employees  from  one  department  to  another, 
the  company  decided  to  analyze,  classify  and  standardize 
its  occupations  and  rates,  and  appointed,  accordingly,  an 
"Occupations  and  Rates  Committee"  to  carry  on  the 
work. 

It  was  found  that  the  original  list  of  400  distinct  occu- 

*  Industrial  Management,  May,  1918. 


312  PRINCIPLES  OF  BUSINESS 

pations  could  be  condensed  into  170,  which  were  adopted 
as  standard,  the  aim  being  to  have  as  few  as  possible  and 
still  to  let  each  be  distinguished  by  some  peculiarity,  so 
that  it  would  not  be  confused  with  any  other  occupation. 

The  rates  for  each  occupation  were  then  tabulated  and 
equalized,  and  two  books  were  made  up :  ( i )  the  fore- 
man's book,  showing  all  occupations  used  in  his  section 
and  the  rates  which  the  foreman  was  authorized  to  pay; 
(2)  the  superintendent's  book,  showing,  for  every  occu- 
pation used  in  the  works,  all  the  sections  using  it  and  the 
rates  of  pay  authorized. 

Since  the  most  logical  classification  of  workers  is  one 
based  on  the  workman's  value  to  industry  in  his  particu- 
lar occupation,  all  workmen  receiving  the  same  rate  were 
put  in  the  same  class,  regardless  of  occupation.  Five 
classes — A,  B,  C,  D,  E — were  established,  distinguished 
as  follows : 

Class  A — Leaders,  experimental  workers,  men  with 
highest  skill  and  judgment. 

Class  B — Accurate,  dependable  workers,  less  experi- 
enced. 

Class  C — Workmen  proficient  in  certain  lines  only, 
these  being  usually  repeated  or  routine  operations. 

Class  D — Workmen  who  could  soon  be  promoted  to 
Class  C. 

Class  E — Unskilled  workmen. 

Several  wage-systems  are  used;  in  each  of  these  the 
"hiring"  rate  is,  of  course,  the  minimum.  The  minimum 
pay  in  any  class  is  usually  the  maximum  hiring  rate  for 
that  class,  and  an  increase  is  ^iven  for  increased  skill; 
opportunit}''  is  also  given  for  advancement  to  a  higher 


WAGE  SYSTEMS  313 

class.  In  other  words,  the  rate  paid  within  a  given  class 
varies,  between  fixed  limits,  with  the  proficiency  of  the 
individual  who,  when  he  attains  the  maximum  of  the 
class,  is  encouraged  to  try  for  promotion  to  the  class  next 
above  him. 

COLLECTIVE  BARGAINING 

Trade-unions. — Earlier  in  this  chapter  it  was  noted 
that  the  amount  of  wages,  while  fixed  between  the  limits 
of  the  workman's  living  cost  and  the  disappearance  of  the 
employer's  profit,  is  adjusted  between  these  limits  by 
means  of  bargaining.  If  these  limits  are  far  apart,  much 
depends  upon  the  ability  to  make  a  good  bargain.  Or- 
ganizations of  workmen  have  been  formed  in  order  that 
this  bargaining  might  be  made  collective  instead  of  indi- 
vidual. The  individual  bargaining  for  himself  is  at  a 
hopeless  disadvantage,  and  under  any  but  the  most  en- 
lightened management  might  be  compelled  to  accept  a 
wage  rather  near  the  lower  limit — close  to  the  bare  cost 
of    subsistence,. 

Whatever  complaint  may  with  apparent  justice  be 
made  against  the  labor-unions  with  respect  to  their  policy 
of  repressing  individual  advancement,  it  must  be  admitted 
that  if  a  crowd  is  to  remain  a  crowd  it  must  be  held  to- 
gether, the  laggards  urged  forward  and  the  leaders  re- 
strained. 

It  may  be  that  society,  in  the  form  of  the  government, 
will  take  upon  itself  the  responsibility  of  protecting  the 
individual  against  too  bad  a  bargain,  as  the  unions  have 
done  in  the  past;  enlightened  business  also  will  be  con- 
scious of  the  fact  that  the  well-being  of  the  workman  is 
a  source  of  profit  both  to  capital  and  to  labor. 


314  PRINCIPLES  OF  BUSINESS 

Collective  bargaining — hov/  accomplished. — It  is 
possible  that  few  people  not  parties  to  the  making  of  a 
collective  wage-bargain  have  more  than  a  vague  idea  of 
the  actual  mechanism  by  which  the  relations  between  the 
employer  and  the  workmen  in  such  a  case  are  maintained. 
A  n:odern  and  representative  case  of  union  bargaining 
may  be  given,  as  described  in  the  Monthly  Review  of  the 
U.  S.  Bureau  of  Labor  Statistics,  November,  1917.^  The 
arrangement  described  is  that  existing  at  the  time  between 
a  large  manufacturer  and  the  Amalgamated  Clothing 
Workers  of  America.  An  agreement  was  signed  in  191 6 
and  renewed  for  an  additional  two-year  period  in  1917.^ 

Three  agencies  were  established  for  adjusting  the  rela- 
tions between  the  employer  and  the  employee — the  Trade 
Board,  The  Wage  Board,  and  the  Board  of  Arbitration. 

The  Trade  Board. — The  Trade  Board  consists  of  15 
members — 7  being  elected  by  the  employees  from  their 
own  number,  all  of  whom  are  affiliated  witli  the  Amalga- 
mated Clothing  Workers  of  America ;  7  being  representa- 
tives of  the  employing  company;  and  one  being  an 
impartial  chairman,  chosen  by  the  above-mentioned  14 
members  of  the  Board.  All  complaints  except  those 
relating  to -wages  are  referred  to  this  board. 

The  Wage  Board. — The  Wage  Board  consists  of  5 
members — 2  representatives  of  each  party  to  the  agree- 
ment, and  a  chairman,  who  is  the  chairman  also  of  the 
Trade  Board.     The  Wage  Board  has  exclusive  jurisdic- 

^  "Piece-rate  Wage-Systems  in  the  Men's  Clothing  Industry,"  Boris 
Emmet,  Ph.D. 

^  For  a  summary  of  agreements  in  the  clothing  industry  in  Chicago, 
Cleveland,  Rochester  and  Baltimore,  see  Monthly  Labor  Review, 
June,  1922. 


WAGE  SYSTEMS  315 

tion  over  questions  involving  rates  of  wages  and  earnings 
of  employees. 

The  Board  of  Arbitration. — The  Board  of  Arbitration 
consists  of  one  representative  of  each  party  and  a  chair- 
man chosen  by  these  two. 

Appeals  to  the  Board  of  Arbitration  may  be  made  from 
decisions  of  the  Trade  Board  or  the  Wage  Board,  botli 
parties  having  the  right  of  appeal.  The  decisions  of  the 
Board  of  Arbitration  are  final,  covering  the  life  of  the 
agreement. 

Wage  Adjustments. — In  this  establishment  90  per  cent 
of  the  workers  are  paid  by  the  week,  that  is,  on  a  time- 
wage  basis.  The  worker,  however,  is  expected  to  reach 
a  certain  standard  of  production.  The  established 
weekly  rate  is  subject  to  increase,  provided  the  output  of 
the  worker  exceeds  the  standard  set  by  the  company. 

Every  operation  is  standardized  in  terms  of  time  and 
money.  The  time  standard  is  arrived  at  by  time-study 
and  observation,  a  liberal  allowance  being  made  for  con- 
ditions out  of  control.  The  money  standard  is  the  time- 
standard  multiplied  by  a  specific  rate,  the  latter  being  the 
average  earnings  per  hour,  over  a  number  of  weeks,  of 
a  group  of  operatives. 

Records  are  kept  showing  the  weekly  output  of  each 
employee.  At  the  end  of  the  week  the  actual  money 
value  of  the  work  involved  in  the  employees'  output  is 
computed  on  the  basis  of  the  standard  described  above. 
This  actual  money-value  is  known  as  "amount  earned" 
and  is  sought  for  the  purpose  of  comparing  it  with  the 
weekly  wages  paid  to  the  worker.  If  the  "aniount 
earned"  exceeds  the  wage,  the  worker  is  credited  with  the 


3i6  PRINCIPLES  OF  BUSINESS 

excess  as  "gain."  Such  gains  are  the  basis  for  the  grant- 
ing of  an  increase  in  weekly  rates  to  employees. 

If,  however,  the  "amount  earned"  is  less  than  the 
standard,  a  "loss"  is  registered  on  the  record.  Names 
of  employees  with  frequent  losses  go  to  the  shop  chair- 
man (a  union  representative)  who  takes  up  the  matter 
with  the  employee.  If  losses  continue,  the  employee  is 
summoned  before  the  Wage  Board  and  given  a  chance  to 
explain.  If  he  has  an  acceptable  excuse  the  matter  is 
dropped;  if  not,  he  is  disciplined  by  reprimand,  suspen- 
sion, or,  in  rare  cases,  discharge. 

In  this  establishment  the  considerations  in  rate-fixing 
are  :  ( i )  the  best  local  market-rate  for  similar  work;  (2) 
the  relative  skill  of  the  worker;  (3)  the  needs  of  the 
worker.  The  final  rate  is  usually  about  25  per  cent  above 
what  is  thought  to  be  the  best  market-rate  for  similar 
work.  In  the  clothing  industry  much  of  the  work  is  let 
to  contractors  and  sub-contractors,  who  by  reason  of 
their  inefficient  business  methods  are  compelled  to  under- 
pay their  help.  If  there  were  a  general  standardization 
of  rates,  Dr.  Emmet  observes,  these  sweat-shops  would 
be  eliminated  and  the  level  of  competition  would  be 
raised — the  basis  of  competition  becoming  the  ability  to 
organize,  manufacture  and  sell,  and  not  the  policy  of  pay- 
ing the  lowest  possible  wage. 

The  unions,  as  is  well  known,  maintain  a  policy  of 
opposition  to  piece-work  in  any  form,  even  when  a  bonus 
is  paid,  and  in  their  agreements  with  employers  provide, 
whenever  possible,  that  any  change  from  a  time  basis  to 
a  piece  basis  shall  be  made  only  upon  the  initiative  of  the 
employees. 


I 


WAGE  SYSTEMS  317 

Non-union  collective  bargaining. — A  non-union  col- 
lective bargaining  plan  instituted  by  a  clothing  manu- 
facturing company  is  described  in  the  MontJily  Labor 
Review,  August,  1918/  The  three  years'  operation  of 
the  plan  has  resulted  in  putting  on  a  collective  basis  the 
wage  bargaining  of  the  establishment,  as  well  as  that 
of  hours,  discipline,  discharges,  and  adjustment  of  griev- 
ances. Under  the  scheme  as  described,  there  are  three 
separate  bodies,  known  respectively  as  the  senate,  the 
cabinet  and  the  house  of  representatives.  The  senate  and 
the  cabinet,  both  of  which  represent  the  interests  of  the 
company,  were  created  in  June,  19 14.  The  organization 
of  the  employees,  termed  the  house  of  representatives, 
was  formed  one  year  later. 

The  members  of  the  senate  are  salaried  employees 
directly  connected  with  the  planning  of  the  work  of  the 
establishment — heads  of  departments,  superintendents 
and  assistants. 

The  members  of  the  house  of  representatives  are 
elected  by  popular  vote  of  employees,  in  the  ratio  of  one 
representative  for  every  fifteen  employees,  but  each  de- 
partment, however  small,  has  at  least  one  representative. 
Employees  are  not  eligible  to  election  unless  they  have 
been  in  continuous  service  for  at  least  six  months.  Elec- 
tions are  held  twice  a  year. 

The  cabinet  consists  of  members  of  the  executive  board 
of  the  company,  and  has  the  final  decision  of  all  matters 
referred  to  it  by  the  joint  action  of  the  house  and  the 
senate.  While  the  cabinet  possesses  final  power,  approval 
is  usually  given  to  any  action  of  the  lower  bodies. 
1  Boris   Emmet,  Ph.D.,   "Non-union  Collective  Bargaining  Plan." 


3i8  PRINCIPLES  OF  BUSINESS 

An  interesting  solution  of  the  wage-increase  problem 
under  the  present  abnormal  conditions  was  arrived  at  by 
the  joint  action  of  the  house  and  senate  and  approved  by 
the  cabinet.  Since  it  is  against  the  policy  of  the  estab- 
lishment ever  to  reduce  a  wage-rate  once  established,  and 
since  the  high  cost  of  living  has  made  unusual  rates  of 
wages  necessary,  perhaps  only  temporarily,  the  problem 
of  increased  wages  was  solved  by  the  giving  to  each 
employee  a  separate  "high-cost-of-living  pay  envelope" 
each  month.  The  amount  of  the  extra  payment  each 
month  is  figured  by  using  Bradstreet's  index  figures  as  a 
basis,  these  index  figures  representing  an  average  of  the 
prices  of  96  articles  used  in  everyday  life.  As  the  prices 
of  these  articles  change,  the  index  figures  change,  so  that 
they  are  a  fair  measure  of  the  increase  in  the  cost  of  liv- 
ing. This  arrangement  was  made  retroactive  to  Decem- 
ber, 191 7,  when  the  demand  of  the  employees  for  in^ 
creased  wages  was  presented. 

The  foregoing  descriptions  of  the  various  wage-sys- 
tems and  the  observations  which  have  incidentally  been 
made  are  in  the  nature  of  a  consideration  of  the  question, 
"What  are  wages  and  what  is  the  basis  of  their  pay- 
ment?'' We  have  seen  that,  from  the  standpoint  of  busi- 
ness, wages  are  the  amount  which  must  be  paid  to  the 
laborer  to  obtain  his  most  profitable  services,  which, 
according  to  circumstances,  may  or  may  not  include  in- 
telligence, co-operation  and  good-will.  Wage-systems, 
we  observe,  are  the  means  whereby  business  measures 
or  attempts  to  measure  the  service  paid  for. 

The  important  question  which  follows  next  in  order  is 
"How  can  the  labor  cost  be  reduced?"     This  does  not 


WAGE  SYSTEMS  319 

mean  "How  can  wages  be  lowered  ?"  It  is  not  only  pos- 
sible but  probable,  or  even  inevitable,  that  reducing  labor 
costs  will  actually  raise  wages,  for  the  reason  that  produc- 
tion will  be  cheapened  and  increased,  thereby  adding  to 
the  economic  wealth  which  all  men,  laborers  included, 
must  share  in.  This  problem  is  discussed  in  the  next 
chapter  under  the  title,  "The  Control  of  Labor." 

BIBLIOGRAPHY 

Taylor,  F.  W.,  Shop  Management. 

Babcock,  George  D.,  Taylor  System  in  Franklin  Management. 

Thompson,  C.  Bertrand,  Scientific  Management. 

Kent,  Robert  Thurston,  Wage  Systems  of  Scientific  Management. 

Hoxie,  R.  F.,  Scientific  Management  and  Labor. 

Gantt,  H.   L.,   Work,   Wages  and  Profits. 

Gantt,  H.  L.,  Industrial  Leadership. 

Burrit,  Dennison,  Gay,  Heilman  and  Kendall,  Profit  Sharinq. 

Gilbreth.  F.  B.,  Motion  Study. 

Commons,  John  R.,  Labor  Administration. 

Fergusson,  William  B.,  Estimating  the  Cost  of  Work. 

Ryan,  John  A.,  A  Living  Wage. 

Alerrick,  Dvvight  V.,   Time  Studies  as  a  Basis  for  Rate  Setting. 


CHAPTER    XV 

THE  CONTROL  OF  LABOR 

ADMINISTRATIVE  CONTROL  OF  LABOR 

The  control  of  industry. — Industry — the  production 
of  want-satisfying  goods — is  carried  on  by  the  various 
types  and  classes  of  business  organizations.  Each  busi- 
ness organization,  as  we  have  noted,  is  the  result  of  the 
uniting  of  certain  elements  contributed  respectively  by 
capital,  labor  and  the  public.  Each  of  these  three,  hav- 
ing made  its  contribution,  desires — if  not  absolute  con- 
trol— as  large  a  measure  of  control  of  industry  as  it  can 
obtain.  Out  of  this  desire  for  the  ultimate  power — the 
right  to  say  finally  what  shall  be  or  shall  not  be  done — 
arise  the  most  bitterly  contested  industrial  problems  of 
the  day. 

Capital,  holding  the  superior  strategic  position,  until 
quite  recently  regarded  itself  as  the  sole  owner  of  a  busi- 
ness enterprise,  with  the  sole  right  to  determine  and 
direct  the  policies  of  the  business. 

The  public,  by  means  of  legislation,  restricts  more  and 
more  the  privileges  which  capital  has  possessed;  a  more 
radical  element,  represented  by  so-called  socialism,  would 
deprive  capital,  as  it  now  exists,  of  its  privileges  alto- 
gether. Many  industrial  enterprises  have  been  taken  over 
by  the  public  and  are  operated  as  "public  utilities."  The 
list  of  utilities  known  as  public  utilities  constantly  grows; 
the  problem  involved  is  merely  one  of  efficiency  of  opera- 

320 


THE   CONTROL   OF  LABOR  321 

tion — whether  the  utiHty  can  serve  the  pubUc  more  ef- 
fectively as  a  monopoly  owned  and  operated  by  the  pub- 
He  ;  as  a  monopoly  under  private  ownership,  but  regulated 
by  the  public ;  or  as  a  competing  enterprise,  under  private 
ownership  and  management. 

Labor,  represented  by  such  of  its  organizations  as  have 
not  forced  themselves  to  be  regarded  not  as  members, 
but  as  enemies  of  society,  seeks  to  attain  such  power  as 
to  enable  itself  to  control  the  processes  and  conditions 
of  industry.  Organized  labor  is  content  to  let  the  nom- 
inal ownership  of  capital  rest  where  it  may,  but  desires 
to  lay  down  the  conditions  upon  which  labor  shall  be 
employed.  The  desire  for  control  extends  not  only  to 
the  fixing  of  the  hours  of  labor  and  the  rates  of  wages, 
but  also  to  the  methods  of  operation.^ 

So  long  as  the  interests  of  capital,  labor  and  the  pub- 
lic are  divergent,  or  apparently  so,  the  conflict  between 
them  must  continue.  These  interests  in  reality,  however, 
are  not  divergent,  but  are  mutual,  if  not  identical.  The 
situation,  which  must  eventually  be  recognized,  may  be 

^The  feature  of  scientific  management  which  seems  to  be  most 
keenly  resented  by  skilled  labor  is  that  whereas  the  knowledge  of 
the  mechanism  or  processes  of  production  was  formerly  regarded 
as  the  peculiar  property  of  the  body  of  skilled  workmen,  accumu- 
lated by  themselves  through  generations  of  practical  experience  and 
transmitted  from  one  to  the  other,  and  held  by  the  workmen  them- 
selves somewhat  as  a  salable  commodity,  scientific  management 
has  taken  away  from  the  workmen  this  property,  consisting  of  their 
accumulated  knowledge  or  skill,  and  has  transferred  it  to  the  keep- 
ing of  capital  instead,  where  it  exists  in  the  form  of  tabulated  and 
detailed  instructions,  so  that  by  means  of  an  instruction  card  an 
unskilled  laborer,  with  a  short  course  of  training,  can  perform  the 
operations  which  formerly  could  not  be  performed  except  by  a 
skilled  workman.  The  fact  that  sciejitific  management  has  made 
radical  changes  in  the  manner  of  performing  the  various  operations 
does  not  affect  the  essential  fact — that  the  processes  under  the 
new  regime  are,  so  to  speak,  the  property  of  the  capitalist  and  not 
of  the  workman. 


322  PRINCIPLES  OF  BUSINESS 

summed  up  in  a  single  sentence :  The  proper  purpose  of 
industry  is  the  production  of  the  greatest  quantity  of 
want-satisfying  goods,  at  the  least  material  and  human 
cost/  In  other  words,  the  function  of  industry  is  the 
production  of  wealth;  the  distribution  of  wealth  is  a 
separate  problem,  and  one  which  will  be  taken  care  of 
by  the  operation  of  economic  laws,  by  mutual  agree- 
ment of  the  parties  at  interest,  or  by  the  arbitrament  of 
society.  By  this  it  is  not  meant  that  any  of  the  parties 
at  interest  should  neglect  any  justifiable  means  of  secur- 
ing a  fair  distribution  of  the  products  of"  industry,  but 
that  the  purpose  of  such  an  endeavor  is  defeated  in  ad- 
vance if  the  means  made  use  of  include  interference  with 
the  efficient  operation  of  the  industrial  machine.  "Sol- 
diering," to  make  the  j-ob  last  longer  or  to  force  the 
employment  of  additional  laborers;  the  shortening  of 
hours,  if  with  the  same  ends  in  view ;  opposition  to  im- 
proved machinery  and  methods;  strikes,  shut-downs,  or 
other  methods  of  curtailing  production,  in  order  to  force 
wages  or  prices  upward — all  these  defeat  their  own 
purposes. 

Centralization  of  control  is  essential. — In  order  that 
the  most  efficient  production  may  be  obtained,  the  func- 
tions of  the  industrial  organization  must  be  correlated, 
coordinated  and  directed  by  a  single  authority  exercising 
control  of  the  entire  mechanism.  Under  the  stress  of 
war,  industry  as  a  whole  is  so  controlled  by  the  Govern- 
ment.    Ordinarily,  however,  a  correlation  and  common 

^In  this  connection  it  must  be  remembered  that  what  we  refer  to 
as  a  material  cost  is  in  the  last  analysis  a  human  cost,  for  the 
destruction  of  capital  in  the  processes  of  production  is  the  destruc- 
tion of  what  has  been  produced  by  human  effort  in  the  past. 


THE   CONTROL   OF  LABOR  323 

direction  of  business  organizations  is  prohibited,  through 
fear  of  misuse  of  the  power  which  would  be  acquired  by 
those  in  control.  Such  a  centralization  of  control  within 
a  single  business  organization,  fortunately,  is  not  for- 
bidden, although  it  is  difficult  to  attain  to  the  degree  de- 
sirable, because  of  the  attempts  at  retention  of  control 
made  by  the  three  several  contributors — capital,  labor 
and  the  public. 

From  the  situation  as  outlined  briefly  and  inadequately 
above,  it  would  seem  that  for  the  good  of  all — that  is, 
for  the  securing  of  the  greatest  production  at  the  least 
economic  cost — the  business  organization  should  be  con- 
trolled by  a  single  authority  representing  not  one  party 
at  interest  to  the  disadvantage  of  the  rest,  but  repre- 
senting impartially  capital,  labor  and  the  public.  It  is 
possible  for  the  modern  business  manager  or  adminis- 
trator to  hold  such  a  position,  especially  when  he  is  in 
active  control  of  a  corporation  with  a  large  number  of 
stockholders,  who  are  not  closely  in  touch  with  the 
operation  of  the  business.  Such  a  manager  or  admin- 
istrator is  most  successful  when  his  policies  gain  the 
approbation  of  the  stockholders,  the  co-operation  of  the 
employees,  and  the  good-will  of  the  public.  Without 
these,  a  permanent  success  may  be  considered  impossible. 

What  is  meant  by  the  control  of  labor? — The  fore- 
going paragraphs  have  been  necessary  in  order  that  we 
might  have  a  specific  point  of  view  from  which  to  ob- 
serve and  interpret  the  various  movements  looking  to  the 
control  of  labor.  We  may  assume  that  no  attempt  at 
labor  control  is  to  be  commended  if  its  purpose  is  other 
than  to  promote  economical  production,  and  by  econom- 


324  PRINCIPLES  OF  BUSINESS 

ical  production  we  mean,  as  explained  above,  production 
that  is  accomplished  at  the  least  material  and  human 
cost.  Obviously,  laborers  themselves  cannot  effect  an 
economical  control  of  their  own  labor,  for  they  lack  a 
knowledge  of  the  conditions  in  general  to  which  a  busi- 
ness must  adapt  itself;  they  lack  the  power  to  control 
other  functions  of  the  business  with  which  the  labor 
function  must  be  correlated  and  coordinated.  The  con- 
trol of  labor,  then,  must  be  the  directing  of  labor  by  a 
central  authority  for  the  purposes  of  economical  produc- 
tion. 

If  labor  surrenders  control,  how  may  its  interests 
be  protected? — If  labor  must  surrender  itself  to  the 
direction  of  a  central  authority,  how  may  it  be  assured  of 
a  fair  share  in  the  distribution  of  the  wealth  which  it 
helps  to  create?  There  would  seem  to  be  only  three 
reasonably  workable  methods,  one  of  which,  we  have 
seen,  is  indefensible  from  the  economic  standpoint — the 
use  of  force,  or  threats  of  restricted  production.  The 
remaining  methods  are  ( i )  appeal  to  public  opinion  or  to 
boards  of  arbitration;  (2)  the  enactment  of  legislation. 
The  success  of  either  of  these  means  is  contingent  upon 
an  intelligent  setting  forth  of  the  facts  involved  and  the 
urging  of  the  claim  upon  a  basis  of  justice.  We  cannot 
believe  that  these  means  would  fail,  although  legislation 
unsupported  by  public  opinion  is  of  little  or  no  value. 
As  business  becomes  more  enlightened,  it  will  be  seen 
more  clearly  how  the  well-being  of  each  element  of  the 
business  organization  is  dependent  upon  the  well-being 
of  each  other  element. 

Wages  not  an  economic  cost. — For  accounting  pur- 


THE   CONTROL   OF  LABOR  325 

poses,  in  order  to  determine  the  financial  profit  made  by 
a  business  enterprise,  the  payment  of  wages  is  included 
among  the  costs  of  production.  In  the  economic  sense, 
however,  the  payment  of  wages  is  not  a  cost,  but  a  dis- 
tribution, of  the  products  or  profits  of  industry.  Money 
is  a  measure  of  value;  money  wages,  therefore,  are  a 
measure  of  the  value  of  the  laborer's  services,  not  of  their 
cost.  Money  possesses  only  one  utility — exchange- 
ability^— and  this  utility  is  neither  destroyed  nor  dimin- 
ished when  money  changes  hands,  as  in  the  payment  of 
wages — except  that  the  place-value  or  possession-value 
of  this  utility  may  be  in  some  degree  affected,  favorably 
or  unfavorably.  The  real  cost  of  labor,  however,  if  it 
could  be  measured  in  terms  of  money,  would  be  the  value 
of  the  goods  which  must  be  consumed  by  the  laborer  in 
order  that  he  may  do  his  work,  allowance  being  made  for 
the  physical  and  psychic  costs  to  the  laborer  himself — 
the  bodily  and  mental  ills  or  discomforts  consequent  upon 
fatigue,  monotony  of  employment  or  loss  of  personal 
freedom. 

The  rateis  of  wages  at  a  given  place  and  in  given  occu- 
pations are  fixed  largely  by  causes  beyond  the  control 
of  the  individual  employer  or  the  individual  laborer. 
Even  if  a  reduction  in  the  wage  rate  were  an  economic 
saving,  or  if  an  increase  were  an  economic  gain,  the 
possibility  of  adjustment  of  the  wage  rate  could  offer 
but  little  hope  to  the  individual.  The  hope  of  economic 
gain  lies  in  increasing  the  efficiency  of  the  worker.  A 
greater  productivity  with  a  given  economic  cost  is  what 
is  to  be  desired  by  the  employer  and  employee. 

^Johnson,  Money  and  Currency,  ch.  II. 


326  PRINCIPLES  OF  BUSINESS 

REDUCTION   OF   LABOR    COSTS 

How  may  labor  costs  be  reduced? — The  whole  prob- 
lem of  the  control  of  labor,  from  the  viewpoint  of  the 
management,  is  that  of  the  reduction  of  labor  costs.  The 
solution  of  the  problem,  obviously,  is  to  be  found  not 
in  lowering  the  rates  of  wages,  but  in  increasing  the  pro' 
ductivity  of  labor.  We  may  now  consider  in  brief  out- 
line the  practical  methods  by  which  employers  endeavor 
to  increase  the  productivity  of  the  working  force  and 
thereby  to  reduce  the  costs  of  labor. 

1.  Improvements  in  machinery  and  methods  of  work- 
ing. 

2.  Selection  and  training  of  employees. 

3.  Securing  the  co-operation  of  employees. 

4.  Lengthening  the  average  period  of  employment. 

5.  Conserving  the  supply  of  labor. 
Improvements  in  machinery. — It  is  not  to  be  denied 

that  the  employer  looks  upon  the  workman  with  a  very 
practical  eye.  Whatever  protestations  may  be  made  by 
the  employer  with  respect  to  his  solicitude  for  the  work- 
man's welfare,  the  workman  will  be  retained  only  so  long 
as  he  is  useful.  If  a  machine  is  invented  which  will  take 
the  place  of  the  workman  and  perform  his  task  at  a  lower 
cost,  the  machine  is  installed  immediately.  Incidentally, 
this  policy  in  the  long  run  is  of  benefit  to  the  working 
classes  as  well  as  to  the  employing  classes.  When  power 
looms  were  introduced  in  England,  the  resentment  of  the 
spinners  expressed  itself  in  riots  and  destruction  of  the 
machinery.  When  oil  pipe-lines  were  introduced  in 
Pennsylvania,  the  teamsters  tore  them  up ;  the  inventor  of 
the  pipe-line  system  of  transporting  oil  died  without  see- 


THE   CONTROL   OF  LABOR  327 

ing  his  plan  in  practical  operation.  Yet  now,  unobtru- 
sive as  are  the  pipe-lines  and  little  known  to  the  public, 
they  form  a  net-work  over  the  continent.  Despite  the 
lessons  of  industrial  history,  the  workman  of  today, 
dressed  in  machine-made  garments,  sits  by  the  light  of 
his  kerosene  lamp,  devising  means  of  obstructing  the 
progress  of  scientific  management. 

Engine  power  is  usually  cheaper  than  man  power,  and 
once  installed  is  more  controllable.  The  machine,  to  the 
extent  of  its  capabilities,  solves  at  once  the  whole  labor 
problem.  As  compared  with  labor,  the  machine  adheres 
in  its  operation  more  closely  to  the  predetermined  stand- 
ards, costs  less  for  power  and  supervision,  eliminates  the 
turnover  problem,  and  is  capable  of  almost  indefinite 
renewal. 

Since  the  potentialities  of  a  given  machine  are  fairly 
well  understood,  it  is  possible  to  select  machines  of  the 
exact  types  and  sizes  required  for  a  given  purpose.  In 
a  projected  installation  of  machinery,  where  the  outlay 
is  of  sufficient  importance,  the  specifications  covering 
the  installation  are  drawn  by  competent  engineers  with 
the  greatest  care.  The  same  principle  is  now  being 
adopted  in  the  employment  of  men.  While  the  human 
factors  in  production  are  more  variable  than  are  the  ma- 
chine factors  and  are  also  more  adaptable  to  modified 
conditions,  the  human  factors  are  not  less  in  need  of 
scientific  analysis. 

Improvements  in  working  methods. — Better  work- 
ing methods,  developed  by  means  of  time  and  motion 
study,  are  a  direct  means  of  reducing  the  labor  cost.  A 
fact  of  the  greatest  importance  is  that  each  workman  is 


328  PRINCIPLES  OF  BUSINESS 

to  be  looked  upon  not  as  a  unit,  independent  of  his  fellow- 
workmen,  but  as  a  part  of  a  mechanism  each  movement 
of  which  must  be  synchronized  with  every  other  move- 
ment. It  would  be  of  little  use,  for  example,  as  Mr. 
Frank  B.  Gilbreth  explains,  to  increase  the  working 
capacity  of  a  single  bricklayer.  When  a  number  of  brick- 
layers are  engaged  in  building  a  wall,  the  wall  must  rise 
evenly,  and  no  workman  may  build  his  own  section  of  the 
wall  above  the  level  maintained  by  the  working  group. 
Obviously,  since  no  bricklayer  has  authority  over  his 
fellows,  the  only  way  in  which  an  improvement  can  be 
effected  is  by  the  substitution  of  more  efficieiit  methods  in 
the  group  as  a  whole.  The  effecting  of  such  an  improve- 
ment is  distinctly  a  function  of  the  management  and  not 
of  the  workman. 

Physical  capacity  of  the  workman. — When  the  most 
efficient  combination  of  movements  has  been  ascertained, 
it  is  necessary  next  to  determine  the  relation  between  the 
task  and  the  physical  capacity  of  the  workman.  This 
phase  of  the  problem  consists  largely  in  determining- by 
careful  experimentation  the  length  and  frequency  of  the 
rest-periods  required  by  the  nature  of  the  task.  By  means 
of  a  scientific  adjustment  of  the  intervals  of  rest  to  the 
expenditure  of  energy  by  the  worker,  a  larger  day's  work 
may  be  accomplished,  with  less  physical  and  mental  strain. 
An  understanding  of  the  principles  governing  industrial 
fatigue  is  necessary  to  an  intelligent  consideration  of 
working  methods,  as  well  as  of  the  hours  of  labor. 

Fatigue. — The  following  paragraphs,  explaining  the 
sources  of  fatigue,  with  the  considerations  affecting  the 
amount  of  rest  and  sleep  required  by  the  worker,   are 


THE   CONTROL   OF  LABOR  329 

quoted    or    adapted    from    Hollingsworth    and    Poffen- 
berger's  Applied  Psycliology} 

"There  are  two  sources  of  fatigue,  each  of  which  needs  a  brief 

description : 

"First,  fatigue  may  be  the  result  of  the  consumption  of  energy- 
producing  material  as  a  result  of  activity,  very  much  as  the  produc- 
tion of  energy  in  the  steam  engine  requires  the  burning  of  coal. 
A  state  of  absolute  fatigue  would  result  from  a  total  consumption 
of  energy-producing  material,  after  which  work  would  be  impossible 
until  a  new  stock  of  material  was  provided.  The  energy-producing 
substance  in  the  muscle  is  glycogen,  a  chemical  substance  manu- 
factured in  the  liver  and  in  the  muscles,  from  material  taken  from 
the  blood  stream.  Energy  is  set  free  when  the  oxygen  of  the  blood 
unites  with  this  glycogen  in  the  muscle.  In  strenuous  muscular 
activity  the  glycogen  is  used  more  rapidly  than  it  can  be  supplied 
and  consequently  the  supply  is  depleted. 

"Second,  complete  fatigue  from  exhaustion  of  glycogen,  except 
under  extreme  conditions,  does  not  occur  because  activity  is  stopped 
from  another  cause  before  that  danger  point  is  reached.  The  com- 
sumption  of  the  energy-producing  material  leaves  certain  by-prod- 
ucts, among  them  being  carbon  dioxide  and  lactic  acid,  which  act 
as  poisons  to  the  tissues  and  when  permitted  to  accumulate  in  suffi- 
cient quantities,  may  clog  the  muscle  and  retard  or  inhibit  its  action. 
Under  ordinary  circumstances  these  waste  products  are  eliminated 
about  as  rapidly  as  they  are  produced,  but  under  prolonged  activity 
they  accumulate  faster  than  they  can  be  removed.  It  is  the  pres- 
ence of  these  poisons  which  in  most  cases  is  responsible  for  our 
fatigue  states  rather  than  the  actual  exhaustion  of  the  combustible 
material,  glycogen." 

"Fatigue,  in  itself,  need  not  be  harmful,  so  that  the  first  signs  of 
fatigue  do  not  indicate  the  end  of  the  optimum  working  period. 
Theoretically,  the  work  period  should  end  when  the  reduction  due 
to  the  onset  of  fatigue  becomes  enough  greater  than  the  improve- 
ment due  to  practice  or  adaptation,  that  further  production  costs 
too  much  in  energy  for  the  results  obtained.  The  rests  should  be 
just  long  enough  to  permit  recovery  from  fatigue  without  losing 
further  time  or  momentum.  Such  a  schedule  has  been  prepared  for 
the  work  of  folding  handkerchiefs.  Each  hour  of  the  day  is  divided 
into  six-minute  periods,  and  for  each  five  minutes  of  work  there 
is  one  minute  of  rest.  Although  one-sixth  of  the  day  is  spent  in 
rest,  the  more  intense  work  possible  during  the  other  five-sixths 
results  in  about  three  times  as  much  work  from  each  employee. 
Schedules  for  other  sorts  of  work  have  been  prepared  with  equal 
increase  in  efficiency.  A  five-minute-rest  period  for  each  hour  of 
work  is  a  good  schedule   for  mental  work." 

^D.  Appleton  &  Company,  New  York,  1917. 


330  PRINCIPLES  OF  BUSINESS 

Mental  fatigue. — The  foregoing  relates  to  muscular 
fatigue.  With  respect  to  nerve  fatigue  and  mental 
fatigue,  it  is  shown  that  nerve  fatigue,  for  practical  pur- 
poses, cannot  be  separated  from  muscular  fatigue,  since 
one  involves  the  other.  Mental  fatigue  may  follow  nerve 
and  muscle  activity,  although  in  most  cases  it  is  not  the 
onset  of  mental  fatigue  so  much  as  it  is  the  lack  of  inter- 
est and  incentive  which  affects  efficiency.  Proof  of  this 
lies  in  the  fact  that  where  fatigue  is  apparently  present  an 
increased  incentive  will  bring  the  output  up  to  normal. 

Measurement  of  fatigue. — As  for  the  measurement 
of  fatigue,  "measurement  in  terms  of  output  or  produc- 
tion, m  which  each  person  learns  to  interpret  certain 
conscious  signs  as  indicative  of  his  safe  limit,  is  about  the 
only  rule  that  can  be  laid  down.  The  establishment  of 
fatigue  standards  for  various  kinds  of  work  is  one  of  the 
most  important  problems  which  efficiency  engineers  are 
attempting  to  solve." 

Rest  and  sleep. — Fatigue  may  be  removed  by  rest  and 
sleep,  and  sometimes  by  a  change  of  occupation.  A 
change  of  occupation  is  a  rest  only  if  the  fatigue  is 
"local,"  that  is,  confined  to  certain  mechanisms  of  the 
body.  If  fatigue  is  due  to  a  general  exhaustion  of  en- 
ergy-producing material  a  change  of  occupation  is  not  a 
rest,  although  lighter  work  may  bring  relief. 

While  the  problem  of  rest-intervals  during  the  day  is  a 
direct  problem  of  business  management,  and  of  more  than 
sufficient  importance  to  justify  the  attention  which  has 
been  given  to  it  here,  the  problem  of  the  amount  of 
sleep  required,  although  also  of  interest,  is  less  intimately 
associated  with  our  subject.     It  will  be  sufficient  to  give 


THE  CONTROL  OF  LABOR  331 

the  conclusions  of  the  authors  quoted  above — that  to  a 
certain  extent,  and  more  so  for  some  individuals  than 
for  others,  relaxation  may  take  the  place  of  sleep;  that 
if  sleep  results  from  fatigue  and  constitutes  a  process  of 
repair,  obviously  the  amount  of  sleep  required  must  de- 
pend upon  the  amount  of  cumulative  fatigue.  The 
amount  of  sleep  required  is  a  problem  to  be  solved  for 
each  individual  case  and  must  be  sufficient  to  keep  the 
worker  in  a  state  of  physical  and  mental  efificiency,  this 
to  be  determined  by  the  amount  and  quality  of  work 
done  over  a  long  period  of  time.  In  no  case  should  tests 
be  limited  to  periods  as  short  as  one  or  two  weeks,  for 
cumulative  effects  might  be  harmful  and  yet  not  show 
themselves  within  this  time. 

The  eight-hour  day. — From  the  point  of  view  of  the 
management,  there  is  little,  if  any,  essential  difference 
between  the  problem  of  the  length  of  the  work-day  and 
that  of  the  number  and  frequency  of  the  rest-periods 
within  the  day.  What  is  desired  by  the  management  is 
the  most  economical  production — the  greatest  return  for 
the  wages  paid,  consistent  with  the  physical  well-being 
of  the  worker.  If  this  can  be  secured  with  an  eight- 
hour  day,  the  management  will  favor  the  eight-hour  day.^ 

There  is,  perhaps,  no  especial  reason  why  the  eight- 
hour  day  should  have  been  chosen  as  the  standard  work- 
ing day  by  those  who  have  been  contending  for  shorter 
hours,  except  that,  in  the  first  place,  an  eight-hour  day 

^The  distinction  must  be  remembered  between  the  eight-hour  day 
as  a  working  period  and  the  eight-hour  day  as  a  basis  for  the  com- 
putation of  wages.  In  many  cases  the  eight-hour  day  is  desired  by 
the  workers  merely  for  the  sake  of  the  overtime  rates  which  apply 
as  they  continue  to  work  ten  or  twelve  hours  a  day  as  before.  The 
present  discussion  is  based  on  an  actual  work  day  of  eight  hours. 


332  PRINCIPLES  OF  BUSINESS 

is  shorter  than  a  nine,  ten  or  twelve-hour  day,  and  its 
adoption  would  be  something  gained  ;  also  that  when  work 
is  continuous  through  the  twenty- four  hours,  the  eight- 
hour  day  makes  possible  three  "shifts"  of  equal  length. 

During  the  period  of  a  national  emergency,  such  as  the 
European  War,  the  interests  of  capital  and  labor  may 
become  merged  with  the  interests  of  society.  But  even 
during  such  a  period,  the  self-seeking  instincts  of  capital 
and  labor  are  revealed  in  inflated  profits  and  in  wage 
scales  that  make  soldiers'  pay  for  the  most  laborious  work 
and  the  greatest  risks  seem  ridiculous.  Even  during  that 
period  of  stress,  labor  insisted  upon  its  strategic  advan- 
tage to  obtain  from  the  Government  the  Adamson 
Law,  limiting  the  hours  of  railroad  labor.  In  ordinary 
times,  however,  there  is  no  denying  the  fact  that 
the  employer  always  wants  more  work  in  exchange  for 
less  wages,  and  that  the  employee  always  wants  more 
wages  for  less  work.  Shorter  hours  are  a  form  of  higher 
wages.  It  is  unlikely  that  if  the  eight-hour  day  should 
become  universal  the  workers  would  be  content  with  eight 
hours — in  all  probability  they  would  contend  for  a  six- 
hour  day  as  earnestly  as  they  now  contend  for  the  eight- 
hour  day.  In  fact,  a  demand  for  the  six-hour  day  is 
already  incorporated  in  the  Socialist  platform.  The  de- 
mand for  tlie  shorter  working  day,  on  the  part  of  the 
workers,  is  a  demand  for  higher  wages,  to  which  there 
is  no  limit,  except  the  capacity  of  the  employer  to  pay. 

In  general,  there  is  but  little  connection  between  the 
length  of  the  working  day  and  the  amount  of  energy 
expended  by  the  worker.  Conditions  vary  with  every 
industry,  every  business  and  every  individual.     What  is 


THE   CONTROL  OF  LABOR  333 

a  reasonable  length  of  day  for  some  occupations  and 
some  individuals  would  be  far  too  long  or  far  too  short 
for  others,  with  respect  to  its  demands  upon  the  worker's 
store  of  energy.  It  is  essential,  in  any  case,  that  the 
day  be  short  enough  to  protect  the  worker  from  the  ef- 
fects of  over-fatigue. 

As  we  have  noted  in  the  chapter  on  "Wages,"  how- 
ever, the  worker  is  paid  not  only  for  expending  his  en- 
ergy, but  also  for  giving  up  his  time  and  personal  free- 
dom. With  respect  to  the  element  of  time,  as  distinct 
from  that  of  the  expenditure  of  physical  energy,  it  is 
much  less  difficult  to  fix  upon  a  length  of  work-day  which 
tends  to  be  fair  to  all  alike.  The  worker  should  have 
a  reasonable  amount  of  time  left  for  his  own  purposes, 
as  distinct  from  those  of  his  employer.  He  should  have 
also  a  reasonable  time  for  self-improvement,  which  is 
profitable  to  the  employer,  as  well  as  to  himself.  Since 
the  worker  must  spend,  in  most  cases,  several  hours  a 
day  in  attending  to  his  household  chores,  private  busi- 
ness affairs,  and  the  like,  and  in  going  to  and  from 
work,  if  the  w^ork-day  is  much  over  eight  hours  he  can 
have  but  little  time  for  recreation,  study  or  social  pleas- 
ures. On  this  ground  alone,  it  is  probable  that  the  eight- 
hour  day  is  justified. 

Taking  the  eight-hour  day  as  meaning  the  same  thing 
in  general  as  the  shorter  work-day,  we  may  present 
briefly  the  leading  arguments  in  the  matter — from  the 
points  of  view  of  the  worker,  of  the  employer  and  of 
society.  The  arguments  for  the  shorter  work-day,  from 
the  worker's  point  of  view  and  from  the  social  point  of 
view,  are  set  forth  in  The  Case  for  the  Shorter  Work 


334  PRINCIPLES  OF  BUSINESS 

Day,^  compiled  under  the  direction  of  Mr.  Louis  D. 
Brandeis,  prior  to  his  appointment  as  associate  justice 
of  the  Supreme  Court.  From  the  thousand  pages  or 
more  of  this  volume  we  may  select  a  few  of  the  more 
important  considerations. 

1.  Long  hours  are  a  menace  to  national  vitality,  since 
immunity  from  disease  is  due  chiefly  to  the  individual's 
adequate  power  of  resistance.  Workers  over-fatigued 
and  exhausted  are  more  readily  attacked  by  degenera- 
tive, occupational  and  other  diseases.  In  addition  to 
causing  fatigue  predisposing  to  disease,  long  hours  of 
labor  cause  premature  aging  of  the  worker  and  injury 
through  continued  strain  upon  eyes,  ears  and  other  or- 
gans of  the  body. 

2.  Modern  industry  is  characterized  by  increased 
strain.  Machinery  is  increasingly  speeded  up;  processes 
become  more  complex ;  all  this  involves  a  correspondingly 
greater  physical  strain  upon  the  worker.  What  was  a 
fair  length  of  work-day  under  former  conditions  is  now 
no  longer  reasonable. 

3.  With  the  introduction  of  machinery  and  with  the 
increased  hazard  in  general  to  the  worker,  it  is  imperative 
that  the  worker  shall  be  alert  and  able  to  think  and  act 
quickly  in  emergencies.  "Physiological  reaction  time"  is 
the  name  given  to  the  interval  between  the  occurrence 
of  some  external  phenomenon  and  the  signal  of  its  hav- 
ing been  perceived  by  an  individual.  This  interval  is 
greatly  increased  by  fatigue.  When  the  brain  is  fatigued 
attention  flags  and  reaction  time  is   retarded.     Hence, 

^Brief  for  the  defendant.  Bunting  vs.  The  State  of  Oregon,  U.  S. 
Supreme  Court,  October  Term,  1915. 


THE  CONTROL   OF  LABOR  335 

after  over-exertion,  workmen  are  subject  to  increased 
danger,  because  then  reaction  time  is  greatest  and  atten- 
tion is  at  its  minimum. 

4.  Excessive  working  hours  bring  about  a  moral  de- 
generation, due  directly  to  over-fatigue.  Laxity  of  moral 
fiber  follows  physical  debility.  After  excessive  labor,  the 
overtaxed  worker  is  left  stupefied  or  responds  most  read- 
ily to  coarse  pleasures  or  excitements. 

5.  Overwork  has  an  evil  effect  upon  the  general  wel- 
fare. The  loss  of  human  energy,  due  to  excessive  work- 
ing hours,  is  a  national  loss,  and  must  inevitably  result 
in  lowering  the  nation's  prosperity. 

6.  Shorter  hours  increase  the  efficiency  of  the  workers, 
and  also  lead  to  improvement  in  the  quality  of  output. 

7.  Shorter  hours  and  other  forms  of  higher  wages 
lead  to  improvements  in  the  planning  of  work  by  the 
management.  When  higher  wages  are  paid,  increased 
unit  costs  may  result,  which  may  be  offset  by  an  increase 
in  production,  due  to  a  more  careful  planning  and  sched- 
uling of  work. 

8.  Shorter  hours,  together  with  higher  money  wages, 
lead  to  the  invention  and  adoption  of  improved  machin- 
ery, so  that  the  cost  of  production  is  not  necessarily 
increased. 

9.  Shorter  hours  lead  to  regularization  of  production 
and  continuity  of  employment.  When  no  restrictions  are 
placed  on  the  hours  of  work  in  a  seasonal  industry,  the 
tendency  is  to  concentrate  the  work  in  a  brief  busy  sea- 
son with  long  hours  of  overtime.  Hour  regulation  forces 
a  distribution  of  the  work  over  a  longer  period. 

Some  very  practical  considerations  connected  with  the 


336  PRINCIPLES  OF  BUSINESS 

problem  of  how  many  hours  a  day  it  is  best  to  work  have 
been  set  forth  by  Mr.  W.  A.  Grieves,  Assistant  Secre- 
tary and  Supervisor  of  Welfare,  of  the  Jeffery  Manufac- 
turing Company,  Columbus,  Ohio/ 

"The  other  morning,  as  I  was  going  to  work,  handbills  were  being 
distributed   by  the   advocates   of   the   eight-hour   day. 

"This  circular  gave  a  list  of  shops  that  are  now  operating  on  the 
eight-hour  schedule  at  different  points  over  the  country.  It  was 
ablaze  with  headlines  proclaiming  the  advantages  to  be  gained,  the 
liberties  to  be  won,  and  the  domestic  happiness  to  be  secured  when 
the  advent  of  this  shorter  workday  should  be  a  reality. 

"It  is  true,  p-erhaps,  that  there  are  some  lines  of  work  in  which 
ten  hours  is  too  long  a  period  to  work.  In  fact  there  may  be  lines 
in  which  eight,  yes,  even  six  hours  may  be  too  long.  But  one  does 
not  have  to  reason  deeply  to  discover  that  the  hours  we  work  must 
be  governed  not  by  the  law  of  supply  and  demand,  as  in  the  case 
of  wages,  but  by  production.  If  by  working  eight  hours  one  can 
accomplish  as  much  as  by  working  ten  hours,  why  is  it  that  nearly 
every  factory  over  the  country  is  not  now  only  working  ten  hours, 
but  twelve  to  fourteen,  and  willing  to  pay  time  and  one-half  for  all 
work  beyond  the  ten-hour  limit?     The  answer  is  self-evident. 

"Manufacturing  today  does  not  resolve  itself  into  the  question  of 
human  endurance,  but  rather  that  of  machine  possibilities.  By 
that  we  mean,  the  man  in  the  shop  today  is  not  called  upon  to 
exhaust  his  physical  energ>'  in  ten  hours'  work  to  a  degree  beyond 
that  to  which  he  used  to  exert  himself  to  do  eight  or  even  six 
hours'  work.  As  we  pass  through  the  shops,  it  is  not  an  uncommon 
sight  to  see  men  seated  for  ten,  twenty,  thirty,  and  forty  minutes, 
watching  their  machines  do  the  work.  Machine  production  has  so 
developed  that  the  man  is  no  longer  called  upon  to  exert  great 
physical  energy. 

"The  recent  strikes  over  the  country  do  not  appear  to  us  as 
being  started  for  the  purpose  of  shortening  the  work-day,  but 
rather  to  increase  the  wage  rate.  Now,  why  can  we  not  be  honest 
about  it?  Where  competition  is  keen,  the  employer  knows  that  if 
he  raises  wages  he  must  raise  the  price  of  his  product.  If  he  can- 
not do  this,  he  must  increase  his  production.  If  his  machines  are 
running  to  their  maximum  on  the  ten-hour  schedule,  and  his  prices 
have  been  made  on  that  basis,  any  other  arrangement  must  entail 
danger  all  along  the  line.  Increase  of  production  may  be  equally 
as  difficult,  owing  to  the  fact  that  present  production  is  based  upon 
maximum  output  of  the  ten-hour  day. 

"Every  man  who  works  or  produces  is  a  business  man.  His  labor, 
or  his  ability  to  produce,  is  his  capital.  If  he  limits  his  production, 
he  assaults  his  own  capital,  and  necessarily  goes  backward  instead 
of  forward.  Decreasing  the  profit  by  limiting  the  production  is  a 
most  effective  agent  in  causing  labor  trouble. 

^"The  Eight-hour  Day"  looVa,  March,  1916. 


THE   CONTROL   OF  LABOR         ■       337 

"The  eight-hour  day,  if  it  is  to  come,  and  we  do  not  say  that  it 
should  not,  must  be  brought  about  gradually  and  among  those  lints 
of  industry  that  will  most  readily  lend  themselves  to  the  change; 
but  there  will  always  be  an  element  that  will  not  conveniently  adjust 
itself.  If  we  are  to  work  only  eight  hours  or  six  hours  our  cost 
of  living  will  not  be  lowered,  hence  our  wage  rate  must  necessarily 
rise  to  meet  the  necessity.  This  might  work  out  all  right  if  our 
country  were  in  a  position  to  dictate  the  industrial  policy  of  the 
world.  But  it  is  not.  If  our  production  is  decreased  and  our 
wages  increased,  it  ultimately  means  that  those  countries  that  have 
not  decreased  their  production  or  increased  their  wages  will  be  in  a 
position  to  outsell  us,  no  matter  how  high  a  tarifif  wall  we  may  erect. 
Until  we  can  more  completely  control  the  world  market  through 
a  lower  production  cost,  we  shall  be  compelled  to  act  conservatively 
if  we  wish  to  maintain  our  present  high  standards  of  American 
living." 

The  tendency  of  the  times  undoubtedly  is  toward  a 
general  adoption  of  the  eight-hour  day.  Among  the  con- 
cerns which  have  recently  yielded  to  the  pressure  of  the 
demand  for  a  shorter  working  day  is  the  United  States 
Steel  Corporation,  employing  275,000  men.  The  sub- 
joined announcement  of  the  change  from  the  ten-hour 
to  the  eight-hour  day  is  taken  from  the  New  York  Stifi, 
September  25,  1918: 

The  United  States  Steel  Corporation  has  adopted  the  eight-hour 
basic  day,  according  to  an  announcement  made  yesterday  by  Elbert 
H.  Gary,  chairman  of  the  corporation.  The  principle  of  the  eight- 
hour  basic  day  is  similar  to  that  of  the  Adamson  law  governing 
railroad  employees  and  gives  the  workman  an  eight-hour  day  with 
time  and  one-half  for  overtime  and  double  pay  for  Sundays  and 
holidays. 

Judge  Gary's  statement  follows : 

"The  finance  committee  of  the  United  States  Steel  Corporation 
today  unanimously  approved  the  recommendation  of  the  chairman 
and  president  of  the  corporation  and  of  the  presidents  of  subsidiary 
companies  to  adopt  the  eight-hour  basic  day,  to  become  effective 
October  i,  1918.  The  open  shop  plan  heretofore  in  force  through- 
out the  works  will  be  continued." 

The  corporation  and  its  subsidiaries  have  approximately  275,000 
men  on  their  payrolls  and  the  new  basis  for  a  day's  work  is  con- 
sidered equivalent  to  a  25  per  cent,  increase  in  wages  for  labor. 
The  corporation  now  pays  $4.20  for  a  ten-hour  day  to  common 
labor. 

Following   the   decision   of   the   United    States   Steel 


338  PRINCIPLES  OF  BUSINESS 

Corporation  with  respect  to  the  adoption  of  the  eight- 
hour  basic  day,  it  was  announced  that  the  same  course 
would  be  taken  by  the  entire  steel  industry.  It  is  to  be 
noted  that  the  hours  of  labor  in  reality  are  not  to  be 
shortened,  but  that  the  workmen  will  continue  to  work 
ten  or  twelve  hours  a  day  as  before,  at  a  higher  wage, 
however,  resulting  from  increased  "over-time."  The 
New  York  Times  estimates  the  increase  in  wages  as 
amounting  to  about  ten  per  cent. 

Selection  and  training  of  employees. — Assuming 
tliat  labor-saving  machinery  and  methods  have  been  in- 
stalled and  working  conditions  in  general  made  as  favor- 
able as  possible  with  a  view  to  utilizing  to  the  best  ad- 
vantage the  services  of  the  working  force  that  must  be 
maintained,  the  next  phase  of  the  problem  of  labor-cost 
reduction  is  to  find  and  place  in  their  respective  positions 
the  workers  best  adapted  to  the  various  tasks.  The  vari- 
ous tasks  require  varying  degrees  of  strength  or  skill; 
the  problem  is  to  place  at  each  task  a  worker  with  no 
more  nor  less  strength  or  skill  than  is  required.  If  this 
is  not  done,  one  of  two  things  must  happen :  the  task  will 
be  improperly  performed,  or  else  the  worker's  surplusage 
of  strength  or  skill  will  be  wasted. 

While  there  is  no  more  disastrous  policy  than  that  of 
hiring  low-priced  men  and  expecting  them  to  perform  the 
work  of  competent  men,  it  is  undoubtedly  true,  con- 
versely, that  few  businesses  are  guiltless  of  employing 
expensive  labor  in  the  doing  of  tasks  which,  in  part, 
if  not  in  whole,  could  be  done  fully  as  well  by  relatively 
unskilled  labor.  This  applies  to  the  business  throughout, 
from  the  manager  who  neglects  the  leaving  of  routine 


THE   CONTROL   OF  LABOR  339 

or  petty  details  to  subordinates,  down  to  the  skilled  work- 
man, who  may  be  permitted  to  get  together  his  material, 
or  do  preparatory  work  which,  if  plans  had  been  made 
and"  carried  out,  could  have  been  done  by  men  costing  only 
half  as  much  in  wages/  So  far  as  is  possible  the  vari- 
ous operations  which  enter  into  production  should  be 
segregated  into  groups,  each  composed  of  operations 
which  require  a  somewhat  similar  degree  of  skill,  so  that 
these  groups  or  sets  of  operations  may  be  assigned  to 
workmen  with  no  more  and  no  less  than  the  appropriate 
skill,  and  so  that  the  more  skilled  workman  will  not 
spend  a  part  of  his  time  on  an  operation  which  could 
have  been  included  in  a  lower  group. 

It  is  assumed,  likewise,  that  the  mere  fact  that  a  cer- 
tain workman  can  be  hired  at  low  wages  does  not  mean 
that  it  is  economical  to  employ  him  at  a  low-grade  task, 
if  he  shows  ability  to  perform  tasks  of  a  higher  grade. 

The  employment  department. — One  of  the  most 
successful  innovations  in  management,  having  as  its  ob- 
ject a  more  intelligent  selection  and  training  and  place- 
ment of  employees,  is  the  centralized  employment  depart- 
ment. The  duties  of  the  employment  department  in- 
clude : 

1.  The  keeping  of  the  service  records  of  employees. 

2.  The  maintaining  of  a  list  of  eligible  applicants  for 
positions. 

3.  The  examination,  physical  and  mental,  of  applicants. 

^While  the  employment  of  a  high-grade  workman  at  a  low-grade 
task  causes  a  financial  loss  to  the  employer,  the  economic  loss 
involved  is  not  the  extra  cost  in  wages,  but  the  loss  of  productivity, 
which  would  have  been  increased  if  the  high-grade  workman  had 
been  employed  at  a  task  which  would  have  called   forth  his  skill. 


340  PRINCIPLES  OF  BUSINESS 

4.  The  selection  of  applicants,  and  their  assignment  to 
vacancies. 

5.  The  standardization  of  wages  in  different  depart- 
ments for  similar  work,  which  includes  the  classification 
of  positions,  with  schedule  of  wages  and  name  or  symbol 
for  each  position/ 

6.  The  supervision  of  the  training  of  employees  both 
for  regular  promotion  and  for  the  filling  of  emergency 
positions,  so  that  when  a  vacancy  suddenly  occurs  some- 
one within  the  organization  is  in  readiness  to  fill  it  tem- 
porarily, if  not  permanently." 

In  establishments  where  a  centralized  employment  de- 
partment has  been  instituted,  the  function  of  hiring  and 
discharging  men  is  taken  away  from  the  foreman  and 
given  to  an  employment  manager.  While  this  power  is 
taken  away  from  the  foreman,  it  is  recognized  that  it 
is  important  to  preserve  the  foreman's  good-will  and  to 
maintain  a  spirit  of  co-operation  in  the  sub-departments, 
so  that  a  man  will  not  be  hired  and  put  to  work,  or  kept 
at  work,  without  the  foreman's  consent.  This  concentra- 
tion of  authority  in  a  single  department  responsible  only 
to  the  management  does  away  with  the  favoritism  that 
so  long  has  been  a  hindrance  to  the  promotion  of  men 
upon  their  merits  alone. 

While  the  supervisor  or  foreman  may  not  discharge 
a  workman  from  the  employ  of  the  company,  he  has  the 

^For  classification  of  positions,  see  chapter  on  "Wages." 

2To  facilitate  the  accounting,  where  employees  are  trained  for 
alternate  positions,  and  where  a  well-paid  workman  may  be  tem- 
porarily employed  at  a  low-grade  task,  the  practice  in  some  estab- 
lishments is  to  make  use  of  the  expense  charge  symbol  "retainers'." 
The  cost-keeping  system  in  use  permits  the  excess  wages  paid  in 
such  a  case  to  be  charged  to  "retainers." 


THE   CONTROL   OF   LABOR  341 

right  to  suspend  a  workman,  in  which  event  the  em- 
ployee may  appeal  to  the  employment  manager.  If  the 
workman  is  sustained  in  his  appeal,  and  if  matters  can- 
not be  smoothed  over  so  that  he  may  return  and  resume 
friendly  relations  with  his  former  supervisor,  a  place  will 
be  found  for  him  in  another  department.  Herewith  is 
given  a  self-explanatory  order  covering  such  matters, 
issued  in  the  Franklin  Shops. ^ 

TO  ALL  FOREMEN  AND  DESPATCH  CLERKS 

Subject: — Discharges  and  Disciplinary  Measures. 

Workmen  whose  records  shoiv  that  they  cannot  do  the  work 
satisfactorily,  in  the  department  in  which  they  are  located,  may,  after 
proper  consideration  by  their  Foreman,  be  released  from  that 
department,  but  not  from  the  employ  of  the  company. 

The  Employees'  Record  Card  (Form  A-210)  must  be  filled  out 
by  the  Foreman  and  sent  to  the  Employment  Superintendent  for 
investigation.  The  Time  Office  will  recognize  only  those  payment 
cards  signed  by  the  Employment  Superintendent  and  endorsed  by 
the  writer. 

When  a  workman  violates  the  Company's  rules,  he  must  be  sent 
to  the  Employment  Superintendent  and  the  complete  facts  reported 
at  once  to   the   latter   by  the   Foreman. 

Payment  and  Record  cards  (Form  A-36)  will  hereafter  be  made 
out  by  the  Employment  Superintendent  only  after  the  workman's 
case  is  investigated  and  the  circumstances  warrant  discharging 
him. 

Foremen  have  only  departmental  disciplinary  authority.  The 
Employment  Superintendent  shall  act  on  the  merits  of  each  case  in 
a  fair  and  impartial  manner. 

Securing  the  co-operation  of  employees. — The  plac- 
ing of  employees  in  congenial  positions,  to  which  they  are 
suited  by  nature  and  training,  goes  far  toward  securing 
the  necessary  spirit  of  co-operation. 

It  is  essential,  however,  to  provide  immediate  incei:. 
fives  to  efficient  performance.    The  employee  must  receive 
adequate  wages,  if  his  co-operation  is  to  be  secured,  and 
should  receive  them  under  a  system  in  which  the  amount 

'^Taylor  System  in  Franklin  Management,  p.  81. 


342  PRINCIPLES  OF  BUSINESS 

of  the  wage  varies  directly  with  the  efficiency  of  the 
worker.  Methods  of  payment  which  accomplish  this 
purpose  are  described  in  the  chapter  entitled  "Wage  Sys- 
tems." 

Welfare  work,  if  undertaken  in  sincerity,  may  do  much 
toward  maintaining  a  spirit  of  co-operation  in  the  work- 
ing personnel. 

Profit-sharing  in  its  several  forms  may  also  tend  to 
promote  a  spirit  of  co-operation.  Welfare  work  and 
profit-sharing  are  considered  in  subsequent  sections  of 
this  book,  primarily  in  their  relation  to  the  problem  of 
labor  turnover. 

The  most  effective  means  of  obtaining  the  active  or 
even  enthusiastic  co-operation  of  the  workers  is  to  give 
them  what  is  known  as  a  "square  deal."  The  payment 
of  wages  in  proportion  to  performance  is  one  form  of  the 
square  deal;  the  recognition  of  any  efforts  which  the 
workers  may  make  to  promote  the  interests  of  the  busi- 
ness is  another.  A  third,  and  less  obvious,  form  of  giv- 
ing the  men  a  square  deal,  however,  is  in  the  recognition 
of  the  fact  that  most  men  work  not  only  for  wages,  but 
for  promotion.  When  a  man  casts  in  his  lot  with  a  busi- 
ness enterprise,  he  rightly  feels  that  if  he  can  increase 
his  usefulness  and  fit  himself  to  occupy  higher  positions 
as  they  become  vacant,  he  has  a  first  claim  upon  those 
positions.  If  the  management  cannot  fill  its  higher  posi- 
tions with  men  brought  up  from  the  ranks,  there  is  some- 
thing wrong  with  the  system — the  men  have  not  been 
given  a  fair  opportunity.  The  employer  has  either  failed 
to  provide  for  the  training  of  his  men,  or  has  ignored 
their  claims.    When  an  employee  has  spent  his  spare  time 


THE   CONTROL   OF   LABOR  343 

in  preparing  himself  for  a  better  place,  and  then  sees 
that  place  given  to  an  outsider,  less  competent,  perhaps, 
than  he  knows  himself  to  be,  he  is  filled  with  a  spirit 
of  resentment  instead  of  one  of  co-operation,  and  so 
are  the  other  employees,  in  sympathy  with  him.  He  has 
not  had  a  square  deal,  and  everybody  knows  it. 

The  spirit  of  the  square  deal  expresses  itself  in  the  per- 
sonal relations  between  the  management  and  the  em- 
ployees, as  well  as  in  the  so-called  business  relations. 
The  men  will  work  better  for  a  manager  who  knows  them 
by  name.  Discipline,  of  course,  must  be  maintained,  and 
impudent  "familiarity"  or  boisterousness  strictly  sup- 
pressed, but,  after  all,  men  are  men,  and  not  machines 

A  manager  said  recently :  "We  take  care  of  our  men. 
What  does  it  matter  whether  some  poor  fellow  has  broken 
an  arm  or  one  of  the  ten  commandments?  He  is  in 
trouble  and  needs  a  lift,  and  he  gets  it."  Needless  to 
say,  these  men  take  care  of  their  manager. 


CHAPTER    XVI 

THE  CONTROL  OF  LABOR 

(Continued) 

REDUCTION    OF    LABOR    TURNOVER 

Continuity  of  employment  as  a  factor  in  labor  cost. 

— In  the  preceding  chapter  the  reduction  of  labor  costs 
is  considered  particularly  w^ith  reference  to  the  means 
whereby  the  working  efficiency  of  the  employee  may  be 
increased.  In  the  pages  following,  attention  will  be 
given  specifically  to  the  various  means  of  lengthening 
the  period  of  employment. 

Maintenance  work,  including  profit-sharing  and  hous- 
ing, will  be  considered  here,  since  in  most  of  its  phases  it 
must  be  regarded  as  being  instituted  primarily  for  the 
purpose  of  keeping  men  from  leaving  their  jobs,  although 
designed  as  well  to  promote  a  unity  of  purpose  and  a 
general  spirit  of  co-operation. 

The  modern  organization  of  business  functions  de- 
mands that  the  men  in  charge  of  these  functions  be  so 
familiar  with  the  system  that  they  are  able  to  adopt  as 
habits  the  working  methods  of  the  establishment  in  which 
they  are  employed,  performing  their  tasks  with  the  un- 
conscious ease  that  can  come  only  with  continuous  prac- 
tice. With  each  change  of  occupation,  and  practically 
with  each  change  of  employment,  the  workman  must 
form  new  habits  before  he  can  perform  the  routine  task 

344 


THE   CONTROL   OF  LABOR  345 

with  any  degree  of  efficiency.  For  this  reason,  it  is  de- 
sirable that  changes  be  as  infrequent  as  possible,  and  also 
that  working  methods  in  different  establishments  be  as 
uniform  as  possible,  so  that  when  changes  of  employment 
occur  the  loss  will  be  minimized. 

The  problem  of  labor  turnover. — The  turnover  prob- 
lem is  that  of  avoidable  "hiring  and  firing."  It  would 
not  be  desirable,  even  if  it  were  possible,  to  do  away 
entirely  with  changes  in  personnel.  A  reasonable  number 
of  new  men  with  new  ideas  and  new  enthusiasms,  with 
experience  gained  in  different  places,  are  undoubtedly  an 
asset  to  a  business  organization.  In  reducing  labor  turn- 
over the  aim  is  principally  to  eliminate  the  expense  of 
hiring  and  teaching  men  who  will  not  stay  long  enough 
to  benefit  their  employers  or  themselves.  This  cost  is 
almost  incredible  in  amount — ranging  from  about  $10 
to  $200  for  each  replacement.  The  average  cost  is  per- 
haps $100.  The  cost  is  least  in  replacements  of  un- 
skilled laborers,  and  greatest  in  replacements  of  par- 
tially skilled  laborers,  who  must  be  taught  to  use  high- 
priced  machines,  and  who  are  brought  to  the  point  of 
usefulness  only  by  means  of  expensive  courses  of  train- 
ing, involving  the  consumption  of  materials  as  well  as  a 
loss  of  the  time  of  machines  and  supervisors.  Skilled 
workmen  may  adapt  themselves  to  a  new  job  witli  rela- 
tively little  difficulty,  but  in  any  case  there  is  a  disturb- 
ance of  the  schedules  of  operations  and  an  interference 
with  team-work — to  say  nothing  of  the  other  unavoid- 
able costs  involved.  The  costs  of  replacement,-  roughly 
analyzed,  will  be  seen  to  be  somewhat  as  follows : 

I.  Cost  of  paying  off  old  employees  and  of  finding, 


346  PRINCIPLES  OF  BUSINESS 

interviewing  and  selecting  new  employees,  including  cost 
of  medical  and  other  examinations  and  tests. 

2.  Cost  of  teaching,  including  course  in  training  de- 
partment and  extra  supervision  at  regular  work. 

3.  Cost  of  materials  wasted;  loss  due  to  production  of 
"seconds." 

4.  Loss  due  to  reduction  in  output  ( i )  of  the  new  em- 
ployee and  (2)  of  those  working  with  him,  since  schedule 
is  disarranged. 

5.  Damage  to  machinery;  extra  risk  of  accidents  (i) 
to  the  new  employee  and  (2)  to  those  working  with  him. 

6.  Fixed  charges  of  idle  or  inefficiently  operated  ma- 
chines. 

7.  Proportion  of  overhead  of  employment  and  other 
departments  not  included  in  the  above. 

Calculation  of  labor  turnover. — In  the  usual  sense 
of  the  term,  labor  turnover  means  simply  the  number  of 
replacements  during  a  given  period,  usually  a  year,  ex- 
pressed as  a  percentage  of  the  number  of  employees  on 
the  payroll  at  the  end, of  the  period,  or  of  tlie  average 
number  on  the  payroll  during  the  period.  The  turnover 
may  be  computed  for  each  week  or  month,  and  the  yearly 
rate  derived  from  the  figures  so  obtained.  Occasionally, 
the  rate  of  turnover  is  expressed  in  terms  of  the  average 
length  of  the  period  of  employment,  with  a  year  as  a 
basis — an  average  term  of  employment  of  three  months 
giving  a  turnover  figure  of  400  per  cent,  of  six  months, 
200  per  cent,  of  twelve  months,  100  per  cent,  and  so  on. 

Since  the  number  of  hirings  during  the  period  may  not 
reflect  accurately  the  actual  conditions  prevailing,  espe- 
cially in  cases  where  a  business  is  growing  rapidly,  or 


tHE   CONTROL   OF  LABOR  347 

where  the  demand  for  its  products  is  seasonal,  it  is 
thought  best  to  separate  hirings  into  those  which  are 
avoidable  and  those  which  are  unavoidable,  and  to  cal- 
culate the  rate  of  turnover  on  the  basis  of  the  theoretically 
avoidable  hirings.  This  rate  is  called  the  "refined  turn- 
over rate,"  and  represents,  obviously,  the  portion  of  the 
turnover  which  is  subject  to  reduction.  Certain  data  or 
statistics  are  prerequisite  to  such  a  calculation.  The 
statistics  bearing  on  this  question  should  answer : 

1.  How  many  men  on  the  payroll  represent  a  perma- 
nent increase? 

2.  How  many  represent  hirings  to  fill  places  left  vacant 
from  unavoidable  causes? 

3.  Is  there  a  distinct  seasonal  fluctuation  that  must 
be  met?^ 

Having  secured  the  necessary  records  and  other  data, 
the  "refined"  turnover  rate  may  be  calculated  as  follows  :^ 

Number  at  present  on  payroll 500 

Number  one  year  ago 450 

Permanent  increase 50 

Necessary  replacements 25 

Unavoidable  hirings  (50+25) 75 

Number  of  hirings  during  year 500 

Less   unavoidable   hirings 75 

Theoretically  avoidable  hirings 425 

425 

Refined  turnover, =  8  c;  per  cent. 

500         ^^ 

*  See  Industrial  Management,  May,   1918,   also  September,   1918, 

for  discussions  of  these  features  of  the  turnover  problem. 

2  American  Academy  of  Political  and  Social  Science,  Annals, 
May,   1916. 


348  PRINCIPLES  OF  BUSINESS 

This  calculation  is  made  upon  the  assumption  that  dur- 
ing the  year  425  theoretically  avoidable  hirings  have  been 
made  to  secure  a  working  force  of  500. 

If  the  calculation  were  made  upon  the  basis  of  the 

average  number  on  the  payroll  during  the  year,  instead  of 

the  number  at  the  end  of  the  year,  the  figure  would  be 

500+450  .  425     ^ 

=475.  average  for  year;  =89-5  P^r  cent. 

The  term  "avoidable,"  as  applied  to  hirings,  refers, 
obviously,  to  changes  that  might  have  been  prevented  by 
better  employment  methods,  better  working  conditions, 
and  a  more  even  distribution  of  production  throughout 
the  year. 

Causes  of  leaving  work. — When  employees  leave 
work,  they  have  either  died,  resigned  or  "quit,"  been 
"laid  off,"  suspended,  or  discharged.  An  employee  is 
"laid  off"  either  temporarily  or  permanently  when  there 
is  an  insufficiency  of  work,  or  on  account  of  sickness. 
He  may  be  "suspended"  as  a  disciplinary  measure,  or 
"discharged"  when  unsatisfactory.  It  is  the  custom  in 
many  establishments  to  refuse  to  hire  again  an  employee 
Who  has  once  "quit."  The  fact  that  the  employee  knows 
when  he  is  quitting  that  he  cuts  himself  off  from  any 
chance  of  future  employment  in  the  establishment  un- 
doubtedly tends  to  decrease  the  rate  of  turnover,  although 
the  rule  should  not  be  applied  too  strictly.^ 

1  In  the  Franklin  shops,  the  following  rule  obtains:  "If  a  man 
wilfully  leaves  the  employ  of  the  company  when  we  wish  to  retain 
him,  and  he  is  again  employed,  he  sacrifices  the  credit  for  years  of 
service.  When  men  return  witliin  one  year,  however,  after  having 
been  removed  from  service  l)y  the  company,  no  change  is  made  in 
the  rating.  If  they  return  after  an  absence  of  one  year  or  more, 
the  years  of  absence  only  are  deducted  from  the  rating.  Taylor 
System  in  the  Frankling  Shops,  p.  92. 


THE  CONTROL   OF  LABOR  349 

Figures  (which  unfortunately  have  little  significance, 
because  the  underlying  causes  are  not  ascertainable) 
show  that  in  100,000  cases  where  employees  left  work, 
74.6  per  cent  quit,  12.2  per  cent  were  laid  off,  and  that 
13.2  per  cent  were  discharged.^ 

We  should  like  to  know  why  74,600  men  voluntarily 
left  their  jobs.  If  working  conditions  were  disagreeable, 
they  should  be  improved.  If  wages  were  better  else- 
where, it  is  high  time  that  wages  were  standardized. 
Of  the  I2,20G  who  were  laid  off,  how  many  could  have 
been  kept  at  work  if  production  had  been  regularized — 
that  is,  distributed  more  evenly  over  the  year?  Of  the 
13,200  who  were  discharged,  how  many  might  have  been 
brought  to  the  point  of  usefulness,  by  means  of  a  little 
kindness,  and  a  little  teaching? 

It  has  come  to  be  required,  in  well-managed  estab- 
lishments, that  the  official  in  charge  give  a  statement  of 
the  reason  for  the  occurrence  of  each  vacancy  on  the 
payroll.  Each  employee  who  quits  is  questioned  as  to 
the  reason  why,  and  the  information  is  filed  on  a  card. 
The  purpose  of  this  is  obvious — if  the  causes  of  dissat- 
isfaction can  be  ascertained,  they  may  possibly  be  re- 
moved. 

It  cannot  be  assumed,  of  course,  that  there  is  always, 
or  even  usually,  an  adequate  external  cause  for  the  work- 
man's leaving.  The  roving  spirit,  the  desire  to  see  more 
of  life  and  more  of  the  world,  is  one  which  the  employ- 
ment department  cannot  hope  entirely  to  subdue.  Neither 
is  the  roving  spirit  wholly  to  be  deprecated.  It  is  quite 
possible  that  Columbus  would  not  have  discovered  Amer- 

1  Industrial  Management,  March,  1918. 


350  PRINCIPLES  OF  BUSINESS  . 

ica  if  he  had  been  satisfied  with  a  perfectly  good  job  in 
his  home  town. 

Classification  of  causes  of  leaving  work. — The  fol- 
lowing classification,  by  Miss  Mary  B.  Gilson,  Employ- 
ment and  Service  Superintendent  of  "The  Clothcraft 
Shops,"  indicates  the  nature  of  the  "avoidable"  and  "un- 
avoidable" causes  of  leaving  work: 
"Under  'avoidable'  we  classify: 

E.     Earnmgs 

W.    Work 

T.     Treatment 

C.  Hours  and  other  working  conditions 
"Under  'unavoidable'  we  classify : 

D.  Death 

R,     Retirement 

M.    Marriage 

O.     Promotion  out  of  organization 

L.     Lay-off  or  discharge 

H.     Home  conditions  altered 

V.     Left  vicinity 

S.      Sickness  or  accident 
P.S.     Sickness  previous  to  employment 

N.  In  National  service"  ^ 
Standardization  of  practice  in  computing  labor 
turnover. — In  its  editorial  comment  upon  the  turnover 
data  submitted  by  its  correspondents,  Industrial  Man- 
agement, September,  1918,  points  out  the  need  for 
"standardization  of  names,  definitions  and  formulas 
connected  with  a  term  that  is  of  such  significance  in 
employment    affairs."      The    three    major   points    upon 

"-Industrial  Manapetncnt,  September,  1918. 


THE   CONTROL   OF  LABOR  351 

which  there  is  a  difference  of  opinion  as  to  the 
factors  which  should  be  included  in  computations  of 
labor  turnover,  as  indicated  by  the  data  referred  to  and 
substantially  as  pointed  out  by  the  editors  of  Industrial 
Management,  are : 

1.  Shall  the  rate  be  computed  upon  "hirings,"  or 
"separations"  ? 

2.  Shall  the  employment  figures  be  taken  from  the 
force  report — which  is  made  up  from  the  attendance 
records — or  from  the  payroll  ? 

3.  Shall  all  separations  be  counted,  or  only  the 
"avoidable"  separations? 

Other  points  which  might  be  agreed  upon  are :  Should 
calculations  be  made  weekly,  or  monthly,  as  the  basis 
for  the  year's  complete  figures;  should  the  number  on 
the  force  report  or  payroll  be  that  of  the  end  of  the  com- 
putation period,  or  the  average  for  the  period?  The  ar- 
gument for  the  former  course  would  seem  to  be :  "We 
have  succeeded  in  building  up  our  working  force  to  its 
present  number.  Now  let  us  see  what  it  has  cost  us  to 
reach  this  point — how  many  men  we  have  had  to  hire  and 
fixC  in  order  to  make  the  force  what  it  now  is,  making  al- 
lowance, of  course,  for  the  growth  or  shrinkage  of  the 
business."  The  argument  for  the  latter  course  might  be: 
"We  have  now  a  certain  number  of  men  on  the  payroll, 
but  from  experience  we  know  that  they  cannot  all  be 
regarded  as  permanent  acquisitions  to  the  working  force. 
In  order  to  find  out  what  our  force  really  is,  we  must  take 
the  average  for  the  period  of  computation,  making  due 
allowance  for  the  growth  or  shrinkage  of  the  business." 

Means   of  reducing   labor   turnover. — Since  classi- 


352  PRINCIPLES  OF  BUSINESS 

fication,  even  though  imperfect,  is  an  aid  to  understand- 
ing, we  may  get  a  clearer  idea  of  the  labor  turnover 
problem  and  its  possible  solution  if  we  look  upon  the 
various  means  of  reducing  the  rate  of  turnover  as  com- 
ing under  one  or  the  other  of  the  following  heads : 

1.  Standardization  of  working  conditions  and  wage 
rates  within  the  community,  so  that  employees  will  not 
be  lured  from  one  establishment  to  another  by  higher 
pay  or  more  agreeable  working  conditions. 

2.  Regularization  of  employment,  so  that  fewer  men 
will  be  laid  off  in  a  slack  season  and  hired  again  in  a 
busy  season.  A  lower  wage  rate  with  steady  work  is 
more  to  be  desired  by  the  employee  than  a  higher  rate 
with  periods  of  idleness,  in  which  his  expenses  are  not 
lessened,  even  if  they  are  not  increased.  The  idle  work- 
man usually  must  spend  money  in  looking  for  a  job,  and 
he  has  more  opportunities,  as  well  as  temptations,  to 
spend  money  in  various  other  ways.  The  high  wage- 
rate  prevailing  in  some  occupations  is  to  be  accounted  for 
principally  by  the  fact  that  employment  in  those  occupa- 
tions is  not  continuous. 

The  employer,  particularly  the  manufacturer,  may  do 
much  toward  regularizing  the  production  and  with  it 
the  employment  conditions  of  his  plant : 

(a)  By  planning  as  far  as  possible  in  advance,  pur- 
chasing materials  and  laying  out  the  work,  attention  being 
given  particularly  to  the  creation  of  a  demand  for  staple 
or  standardized  articles.  By  this  means  manufacturing 
can  be  carried  on  farther  in  advance  of  sales  and  more 
evenly  distributed  to  conform  to  the  capacity  of  the 
plant  as  operated  by  a  normal  working  force. 


THE   CONTROL   OF  LABOR  353 

(b)  By  the  manufacture,  during  the  dull  season,  of 
such  articles  or  parts  as  may  be  considered  standard  or 
staple.  Even  although  the  manufacture  of  an  article  in 
question  may  not  safely  be  finished  until  the  season's 
market  preferences  have  been  determined,  certain  parts 
of  the  new  model  can  be  made  with  a  reasonable  cer- 
tainty that  these  standard  parts  will  not  be  included 
among  those  affected  by  changes  in  design. 

(c)  By  insistence  upon  long  delivery-dates,  so  that 
orders  will  not  have  to  be  ''rushed." 

(d)  By  taking  contracts  during  the  dull  season  for 
turning  out  work  for  other  manufacturers,  for  whom  the 
season  may  be  the  "busy"  one.^ 

3.  Assuming  that  such  an  equalization  of  wages  and 
working  conditions  and  regularization  of  production  has 
been  effected,  the  remaining,  means  of  reducing  the  rate 
of  turnover  would  obviously  be  the  creation  of  various 
ties  between  the  workman  and  the  establishment  where- 
in he  is  employed.  Workmen  will  drift  from  one  place 
to  another,  in  spite  of  anything  that  can  be  done,  Ijut 
the  extent  to  which  this  drifting  occurs  will  be  lessened 
if,  on  the  one  hand,  the  apparent  advantages  of  changing 
employment  have  been  removed,  and  if,  on  the  other 
hand,  certain  ties  are  created  which  we  may  classify  as 
(a)  personal;  (b)  financial;  (c)  physical  and  social. 

Among  personal  ties  we  may  include :  the  interest  or 
pride  taken  by  the  men  in  their  work — this  depending 
largely  upon  the  oersonal  relations  between  men  and 
management;  the  friendships  the  employees  may  form; 

^  See  Monthly  Labor  Review,  August,  1918,  "Labor  Survey  of 
Cleveland  Clqak  Industry." 


354  PRINCIPLES  OF  BUSINESS 

and  the  contentment  they  may  have  in  their  surroundings. 
Certain  phases  of  welfare  work  undoubtedly  tend  to 
create  or  strengthen  the  personal  associations  which, 
other  things  being  equal,  would  influence  employees  to 
remain  rather  than  to  leave. 

Among  financial  ties,  besides  prospects  of  promotion, 
would  be  included :  the  various  pecuniary  rewards  for 
continuity  of  service  such  as  are  offered  under  plans  of 
profit-sharing,  stock-ownership  or  pensions  for  retired 
employees.  Group-insurance,  while  not  always  contin- 
gent upon  length  of  service,  may  also  be  included  with 
the  above. 

Among  what  we  have  called  physical  or  social  ties 
may  be  included  whatever  would  make  it  difficult  or  ex- 
pensive for  the  employee  to  move  to  another  place.  In 
this  category,  we  may  include  the  housing  of  employees, 
especially  when  the  employee  is  persuaded  to  purchase 
the  house  he  occupies.  If  the  employee  can  be  estab- 
lished in  a  house  owned  by  or  purchased  from  the  em- 
ployer, in  a  community  with  schools,  churches  and  recrea- 
tion centers,  the  probability  of  the  employee's  leaving 
work  is  greatly  decreased. 

In  the  following  pages  these  phases  of  the  labor  prob- 
lem, together  with  what  we  have  called  the  "conservation 
of  labor,"  will  be  considered  briefly,  under  the  inclusive 
title  "Maintenance  Work." 

"maintenance  work" 

Maintenance  work  defined. — Maintenance  work,  as 
defined  by  Alexander  Fleisher,  Ph.D.,  Supervisor  of  the 
Welfare   Division   of   the   Metropolitan   Life    Insurance 


THE  CONTROL  OF  LABOR  355 

Company,  is :  "That  service  given  by  employers  to  their 
employees,  beyond  the  requirements  imposed  by  law  or 
forced  by  employees,  and  in  addition  to  the  conditions  of 
employment  prevalent  in  their  community."  "Conditions 
of  employment"  here  refers  to  wages,  hours  of  labor, 
safety,  comfort  and  other  conditions.  The  scope  of  main- 
tenance work  is  indicated  by  Dr.  Fleisher  in  the  follow- 
ing synopsis  ■} 

1.  Medical   Work 

(a)  Preventive 

(i)   Medical  examination   (on  entrance  and  annual) 

(2)  Rest  rooms 

(3)  Washing  and  bathing   facilities 

(4)  Home  nursing 

(5)  Lunch  rooms 

(b)  Curative 

(i)  Dispensaries  and  hospitals 

(2)  Special  clinics    (optical,  dental) 

(3)  Tuberculosis  care 

2.  Savings   and    Insurance 

(a)  Loans 

(i)   Remedial 
(2)   Building 

(b)  Insurance 
(i)   Sickness 

(2)  Life 

(3)  Old  age 

(c)  Profit-sharing 

(d)  Savings  plans- 

3.  Recreational  Activities 

(a)   Clubs  and  associations 
(b)   Entertainments,   concerts,  etc. 

4.  Education   of   Workers 

(a)  Training  for  jobs 

(b)  Training  in  jobs 

(c)  Training  in  citizenship 

(d)  Promotion   and    records 

5.  Care  Outside  Working  Hours 

(a)  Housing 

(b)  Recreation 

(c)  Care  of  families 

As  will  be  seen  from  the  synopsis  of  welfare  activities 

^  American    Academy   of    Political    and    Social    Science,    Annals, 
1916. 


356  .PRINCIPLES  OF  BUSINESS 

given  above,  the  work  is  varied,  its  nature  in  any  particu- 
lar case  depending  upon  the  special  needs  of  the  workers, 
or  perhaps  upon  some  whim  of  the  employer.  No  one 
employer,  of  course,  attempts  to  put  into  practice  all  of 
the  plans  outlined  above. 

The  prevailing  interest,  says  Dr.  Fleisher,  seems  to  be 
medical  care;  this  is,  at  any  rate,  the  usual  starting-point 
when  welfare  work  is  undertaken. 

Much  of  the  maintenance  work,  begun  by  the  employer, 
is  continued  by  the  employees,  with  or  without  financial 
assistance  from  the  management.  It  seems  that,  espe- 
cially in  the  case  of  the  social  or  recreational  activities, 
but  also  in  the  case  of  the  building  up  of  employees'  bene- 
fit funds,  the  management  of  the  work  as  w^ll  as  the 
financing  of  it  should  be  left  to  the  employees  themselves, 
the  employer  making  a  minor  contribution,  and  perhaps 
guaranteeing  the  payment  of  any  deficit  that  might  be 
incurred.  Nothing,  however,  that  savors  of  paternalism 
will  be  tolerated,  much  less  of  a  paternalism  that  would 
pay  for  maintenance  work  by  reducing  wages. 

Management  of  employees'  benefit  associations. — 
Of  the  cases  in  which  data  are  obtainable,  75  per  cent 
of  the  employees'  benefit  associations  are  managed  by 
employees  alone;  18  per  cent  jointly;  and  8  per  cent  by 
the  employer  alone.  In  72  per  cent  of  the  associations 
having  managing*  boards,  all  the  members  are  employees ; 
in  10  per  cent  the  management  is  represented  on  the 
boards ;  in  8.3  per  cent  representation  of  one  or  the 
other  is  optional;  in  2.3  per  cent  the  boards  are  com- 
posed of  establishment  officials  alone. ^ 

^  Industrial  Management,  January,  1918. 


THE  CONTROL  OF  LABOR  357 

Group  insurance. — One  of  the  most  successful  forms 
of  maintenance  work  is  the  protection  of  employees  by 
means  of  group  insurance,  which  provides  against  finan- 
cial hardships  resulting  from  accident,  sickness  and  old 
age.  Not  only  is  the  employee  himself  protected,  but  so 
also  are  his  dependents. 

Group  insurance  is  taken  out  by  the  employer  under 
a  "blanket  policy" — only  one  policy  being  issued  to  a 
group,  the  policy  usually  being  without  conditions  other 
than  the  payment  of  the  premium.^ 

In  a  register  which  accompanies  the  policy,  the  names 
of  the  individuals  covered  by  the  policy  are  recorded,  the 
amount  for  which  each  is  insured,  the  names  of  the 
beneficiaries,  the  amount  of  the  individual  premium,  and 
other  essential  data. 

Individual  certificates  are  issued  to  each  individual 
covered  by  the  policy.  These  certificates  recite  the  con- 
ditions under  which  the  policy  remains  effective — these 
conditions  being,  in  the  main,  that  the  employer  continue 
to  pay  the  required  premium  and  that  the  employee  re- 
main in  his  service.  Upon  the  death  or  lesser  misfor- 
tune of  an  employee  insured,  the  check  in  payment  is 
made  out  to  the  order  of  the  beneficiary,  but  is  sent  to  the 
office  of  the  company  for  delivery.  The  fact  that  pay- 
ment is  thus  made  through  the  company  tends  to 
strengthen  in  the  beneficiary's  mind  the  favorable  asso- 
ciation l>etween  the  payment  and  the  employer  whose 
foresight  provided  it. 

Profit-sharing. — Profit-sharing  is  the  distribution  to 
employees  of  a  certain  portion  of  the  profits  of  a  busi- 

1  American  Academy  of  Political  and  Social  Science,  Annals, 
1917. 


358  PRINCIPLES  OF  BUSINESS 

ness,  in  addition  to  their  regular  wages.  In  order  that 
a  plan  may  properly  be  designated  as  a  profit-sharing 
plan,  it  is  requisite  that  the  payments  be  predetermined 
as  a  percentage  of  the  profits  of  the  business,  contingent 
upon  their  being  made,  and  the  time  of  the  calculation  and 
distribution  of  the  profit  must  be  specified. 

It  is  commonly  held  that  profits  so  to  be  distributed  do 
not  form  part  of  the  employee's  wages,  but  it  is  difficult 
to  see  how  the  distinction  can  be  made.  It  is  true  that 
the  profit-sharing  feature  may  be,  or  rather  must  be,  in- 
dependent of  the  regular  wage-system,  except  in  that 
the  regular  wage  may  be  one  of  the  bases  of  calculation 
in  the  apportionment  of  the  profits  to  employees,  yet  the 
fact  cannot  be  ignored  that  wages,  from  the  workman's 
point  of  view,  are  what  the  laborer  is  willing  to  work  for, 
and,  from  the  employer's  point  of  view,  what  the  em- 
ployer must  pay  in  order  to  obtain  the  most  profitable 
service.  If  the  employee  works  in  the  hope  of  receiving 
a  share  of  the  profits,  this  expectation  and  this  share  of 
the  profits  must  be  classed  as  part  of  his  wages.  After 
workmen  have  become  accustomed  to  profit  distributions, 
they  look  upon  them  as  a  deferred  portion  of  their  wages. 

We  are  concerned  only  incidentally,  however,  with  the 
question  of  whether  or  not  profit-sharing  is  a  form  of 
.  wage  payment ;  we  are  interested  in  its  purpose,  its 
methods  of  operation,  and  its  results. 

The  purpose  of  profit-sharing.^ — ^It  seems  clear  that 
profit-sharing,  while  it  may  sometimes  be  prompted  by  a 
sense  of  justice  toward  employees,  is  instituted  by  em- 
ployers primarily  as  a  means  of  reducing  labor  turnover. 
A  share  in  the  profits  is  given,  in  addition  to  regular 


THE   CONTROL   OF  LABOR  359 

wages;  this  in  itself  tends  to  attract  and  hold  the  work- 
man. If,  however,  the  distribution  of  profit  were 
prompted  alone  by  a  sense  of  justice,  the  useful  work- 
man should  have  his  share  even  although  he  had  worked 
only  a  short  time.  The  custom  is,  however,  to  permit 
only  those  employees  to  share  in  the  profits  who  have  a 
record  of  at  least  a  year's  continuous  service.  If  a  work- 
man should  join  in  a  strike  his  continuity  of  service  would 
be  broken  and  he  would  forfeit  his  accumulated  profits. 
Again,  the  increase  given  in  proportion  to  length  of  serv- 
ice beyond  the  one-year  minimum  is  to  be  explained  only 
upon  the  ground  of  the  saving  the  steady  workman  has 
effected  in  holding  down  the  turnover  in  his  particular 
occupation.  This  is  not  an  inconsiderable  service,  for  if 
it  costs,  as  we  have  seen,  possibly  $100  or  more  to  replace 
a  workman,  the  one  who  stays  and  saves  his  employer 
that  expense  once  or  twice  a  year  might  well  be  rewarded 
with  a  payment  in  addition  to  his  regular  wage^.  Inci- 
dentally, of  course,  profit-sharing  may  promote  a  spirit 
of  co-operation  among  the  employees  which  leads  to  in- 
creased production  as  well  as  to  a  better  care  of  tools  and 
materials. 

Forms  of  profit-sharing. — 'Profit-sharing  proper  is 
the  distribution  to  employees  of  a  predetermined  per- 
centage of  whatever  general  profits  are  shown  to  have 
been  made  by  a  business  at  the  end  of  its  fiscal  year  or 
other  period  of  computation.  For  the  purpose  of  profit- 
distribution,  the  employees  are  usually  divided  into  classes 
on  a  basis  of  length  of  service,  the  larger  shares  going  to 
those  who  have  been  longest  in  the  company's  service. 
Within  each  class,  the  amount  received  by  the  employee 


360  PRINCIPLES  OF  BUSINESS 

is  in  proportion  to  the  amount  of  his  annual  wages  or 
salary.  This  fonn  is  called  "general  profit-sharing." 
Other  forms  of  profit-sharing  are  "individual  profit-shar- 
ing" a.nd  "unit  profit-sharing."  Individual  profit-sharing 
is  that  form  under  which  an  employee  receives  a  pre- 
determined percentage  of  the  profit  resulting  from  his 
own  efforts,  as  when  a  salesman  receives  a  share  of  the 
profits  made  upon  the  orders  which  he  secures.  This 
form  of  profit-sharing,  of  course,  is  to  be  distinguished 
from  the  payment  of  a  commission  based  on  the  selling 
price.  Unit  profit-sharing  is  the  distribution  to  em- 
ployees within  a  certain  department  or  branch  establish- 
ment of  a  given  percentage  of  the  profits  made  therein. 

Profit-sharing,  of  course,  must  be  distinguished  from 
gain-sharing^  and  ownership-sharing  (stock-holding  by 
employees)  as  well  as  from  the  distribution  of  bonuses 
or  gifts — payments  made  at  the  discretion  of  the  manage- 
ment and  not  pre-determined  as  a  percentage  of  profits. 

In  a  few  instances,  loss-s-haring  has  been  instituted 
along  with  profit-sharing,  an  amount — sometimes  10  per 
cent — of  the  wages  being  held  back  as  a  margin  to  cover 
a  portion  of  a  possible  loss  during  the  year,  and  to  be 
returned,  along  with  the  agreed-upon  percentage  of  the 
profit,  if  a  profit  should  be  made.  In  actual  practice  this 
plan  has  meant  little  more  than  an  enforced  saving,  and 
a  development  of  a  common  viewpoint  of  men  and  man- 
agement, for  in  the  cases  where  it  can  be  instituted  there 
is  little,  if  any,  risk  of  loss.  Employees  usually  are  will- 
ing to  take  the  risk  of  loss  only  if  the  risk  does  not  appear 

1  Gain-sharing  is  a  wage  increase  based  upon  the  efficiency  of 
the  employee.  Gain-sharing  plans  are  described  in  the  chapter  on 
"Wage  Systems." 


THE  CONTROL   OF  LABOR  361 

to  be  a  real  one — or,  in  other  words,  if  there  is  no  risk. 
A    typical    profit-sharing    plan. — A    modern    profit- 
sharing  plan   (adopted  by  an  English  engineering  com- 
pany in  I9'i6)  provides  as  follows: 

1.  "Company  shareholders  receive  8  per  cent  dividends 
before  any  profit  is  distributed  to  employees. 

2.  Cash  dividends  above  8  per  cent  are  divided  be- 
tween (i)  shareholders,  on  the  basis  of  their  stock  in- 
terests, and  (2)  employees,  on  the  basis  of  their  salary 
or  wages  received  during  the  twelve  months  ending  June 
30,  as  follows : 

Class  A — Two-year  employees,  same  rate  as  to 
stockholders. 

Class  B — One-year  employees,  three-fourths  of  the 
above  rate. 

Class  C — One-half  of  the  above  rate.  (Rule  auto- 
matically excludes  employees  of  less 
than  six  months).  Dividends,  accrued 
to  June  30,  are  to  be  paid  in  December. 

3.  Only  bona  fide  employees  at  time  of  distribution 
(December)  are  eligible,  except  employees  laid  off  on 
account  of  (i)  lack  of  work  or  (2)  sickness. 

4.  Other  ex-employees  have  forfeited  right  of  partici- 
pation. 

5.  Employees  receiving  a  commission  from  the  com- 
pany, or  any  other  share  in  profits  except  dividends  on 
stock,  are  ineligible. 

6.  All  employees  except  those  excluded  as  above  are 
eligible. 

7.  Plan  is  voluntary;  not  a  contract;  may  be  changed 
by  directors  at  any  time ;  any  employee  may  be  discharged 


362  PRINCIPLES  OF  BUSINESS 

at  any  time;  employees  may  not  hold  the  company  to  an 
accounting." 

In  other  plans,  an  annual  bonus  may  be  paid  on  a  basis 
of  salary  and  length  of  service,  ranging  fr6m  perhaps 
2  per  cent  of  the  annual  salary,  in  the  case  of  employees 
in  service  from  one  to  two  years,  up  to  20  per  cent  to 
those  who  have  been  in  service  ten  years.  Service  in 
some  cases  must  have  been  continuous;  in  other  cases 
the  aggregate  of  all  previous  service-periods  is  con- 
sidered. 

Effectiveness  of  profit-sharing  plans. — Profit-shar- 
ing, like  other  forms  of  welfare  work,  is  effective  or, 
in  other  words,  promotes  the  co-operative  spirit  among 
the  workmen  and  reduces  labor  turnover,  only  when 
instituted  by  the  management  in  a  spirit  of  fair  play. 
It  is  certainly  far  less  efficient  than  a  scientific  wage- 
system  in  stimulating  performance.  A  modern  wage- 
system,  such  as  that  in  use  in  the  Franklin  shops,^  rewards 
continuity  of  service  as  well  as  efficiency  in  production. 
Profit-sharing,  however,  is  applicable  in  cases  where  in- 
dividual performance  cannot  be  measured,  as  in  certain 
departments  of  the  Procter  and  Gamble  soap  factories, 
for  example,  and  amid  such  circumstances  would  seem 
to  have  its  proper  place. 

One  danger  attending  the  operation  of  a  profit-shar- 
ing scheme  is  that  if  the  distribution  is  large  enoug'h  to  be 
of  interest,  the  workmen  will  resent  additions  to  their 
number,  since  this  would  decrease  the  share  of  each  in- 
dividual. The  working  force  may  then  be  too  small  for 
the  greatest  efficiency  and  the  men  may  be  overworked. 

1  See  page  303. 


THE   CONTROL   OF  LABOR  363 

The  question  of  whether  a  workman,  when  he  works 
for  wages,  is  paid  for  continuity  of  service — at  any  rate, 
up  to  a  certain  point — as  well  as  for  his  daily  labor,  or 
whether  length  of  service  is  something  outside  of  the 
bargain,  to  be  paid  for  by  an  addition  to  the  regular 
wages,  is  of  little  practical  importance  at  present.  In 
the  present  stage  of  the  ethical  development  of  business, 
the  question  is  not  that  of  what  wage  a  man  is  entitled 
to,  but  that  of  the  wage  in  return  for  which  he  will  render 
the  most  economical  service.  If  profit-sharing  can  estab- 
lish itself  as  a  detached  and  tangible  reward  proportion- 
ate to  the  saving  due  to  continuity  and  length  of  service, 
it  would  seem  to  be  upon  a  firrriibasis.  If,  however,  this 
same  end  can  be  attained  by  an  adjustment  of  the  wage 
equation  (see  "Wages"),  this  latter  means  would  seem 
to  be  preferable.  In  so  far  as  profit-sharing  is  a  means 
of  returning  to  the  employee  what  is  his  due,  as  a  matter 
of  fundamental  justice,  it  can  result  only  in  competing 
with  and  raising  wages  generally,  for  wages,  like  water, 
must  seek  their  own  level,  and  it  does  not  follow,  by  any 
means,  if  money  wages  were  so  raised,  that  real  wages 
would  also  be  increased. 

Ownership-sharing. — Ownership-sharing,  sometimes 
called  co-partnership,  is  a  system  under  which,  with  the 
primary  object,  apparently,  of  lengthening  the  term  of 
service,  the  employer,  instead  of  sharing  cash  profits, 
pays  them  in  the  form  of  stock,  or  permits  or  encourages 
the  employees  to  acquire  stock  in  the  company  bv  pur- 
chase. Many  variations  will  be  found  in  the  methods  by 
which  the  transfer  of  stock  to  employees  may  be  given; 
employees  may  be  given  the  opportunity  to  purchase  stock 


364  PRINCIPLES  OF  BUSINESS 

upon  very  favorable  terms — only,  however,  after  a  speci- 
fied term  of  service.  Unwise  and  unfair  restrictions  are 
frequently  put  upon  the  ownership  of  stock  by  employees. 
Such  provisions  may  be  found  as  that  the  employee  for- 
feits his  stock  when  he  severs  his  connection  with  the 
company;  or  he  may  be  restrained  from  selling  it,  or  in 
case  of  his  death  dividends  may  be  paid  to  his  wife  or 
other  beneficiary  until  the  death  of  the  beneficiary,  upon 
which  event  the  stock  reverts  to  the  company.  Some- 
times, but  rarely,  the  employee  may  become  the  outright 
owner  of  the  shares. 

As  indicating  a  tendency  toward  democratization,  the 
holders  of  employees'  stock  may  be  granted  the  privilege 
of  electing  one  director  who,  being  in  a  hopeless  minority, 
has  but  little  power.  Nevertheless,  there  may  be  an  ad- 
vantage in  that  the  director  may  gain  and  communicate 
to  the  workmen  somewhat  of  the  employer's  point  of 
view,  and  vice  versa. 

The  stock-owning  bonus  plan  of  -the  General  Motors 
Corporation,  described  in  the  following  section,  is  an 
interesting  example  of  ownership-sharing. 

Stock-owning  bonus  plan  of  General  Motors/ — 
"The  General  Motors  Corporation,  with  the  consent  of 
its  stockholders,  has  put  into  operation  a  bonus  plan  which 
will  give  employees  an  increasing  interest  in  the  business 
through  the  distribution  of  stock  among  them.  The 
corporation  had  this  plan  in  mind  last  week  when  the 
shareholders  authorized  an  expansion  from  $100,000,000 
to  $200,000,000  in  the  authorized  common  stock,  and 
from  $50,000,000  to  $100,000,000  in  the  preferred. 

1  New  York  Times,  September  i,  1918. 


THE   CONTROL   OF  LABOR  365 

"The  management  engages  to  establish  a  fund  to  which 
will  be  credited  yearly  an  amount  equal  to  10  per  cent  of 
the  net  earnings  after  deducting  6  per  cent  on  the  capital 
employed  in  the  business,  the  purpose  being  to  buy  stock 
with  the  money.  At  the  end  of  the  year,  beginning  De- 
cember 31  next,  lists  of  employees  entitled  to  a  bonus 
will  be  prepared  in  accordance  with  this  schedule : 

"Senior  bonus  list,  to  be  selected  from  salaried  workers 
receiving  $2,400  and  upward  a  year,  who  will  be  divided 
into  five  divisions,  according  to  merit.  Employees  in  the 
first  division  will  receive  a  considerably  larger  percentage 
of  their  salaries  as  bonuses  than  those  in  the  fifth. 

"Junior  bonus  list,  to  be  selected  from  all  employees 
receiving  less  than  $2,400  a  year.  Except  with  the 
approval  of  the  President,  no  worker  will  be  placed  on 
either  of  these  two  lists  unless  he  has  been  in  the  employ 
of  the  corporation  for  at  least  one  year. 

"Royalty  bonus  list,  comprising  employees  who  are 
rewarded  for  inventions,  suggestions,  ideas,  or  improve- 
ments of  special  value  to  the  corporation.  Each  case  is 
to  be  determined  on  its  merits,  and  rewards  are  to  be 
made  irrespective  of  the  earnings  of  the  corporation  or 
the  length  of  service  of  the  employee,  the  criterion  being 
the  benefit  realized  by  the  use  of  the  invention  or  improve- 
ment. 

"The  distributions  will  be  made  in  March  of  each  year 
by  the  Finance  Committee.  Any  undistributed  balance 
in  the  bonus  fund  is  to  l>e  carried  forward  from  year  to 
year." 

Housing. — Housing  is  a  form  of  welfare  work  in 
which  the  employer  seeks  not  only  to  provide  living  con- 


366  PRINCIPLES  OF  BUSINESS 

ditions  which  will  raise  the  general  efficiency  of  his  work- 
ing force,  keep  at  least  a  part  of  the  force  where  they  are 
in  easy  reach  both  for  ordinary  work  and  for  emergen- 
cies, but  which  also  will  enable  him  to  create  what  we  may 
call  physical  and  social  ties  from  which  the  worker  could 
extricate  himself  only  with  difficulty — the  primary  pur- 
pose of  housing  being  to  reduce  labor  turnover. 

The  housing  problem  is  as  old  as  the  factory  system. 
Xhe  location  of  a  factory  or  similar  industry  is  often 
determined  by  natural  conditions,  such  as  existence  of  a 
water-power  site,  or  a  coal  deposit.  Workmen  must  be 
secured,  so  it  becomes  necessary,  especially  in  a  sparsely 
populated  territory,  to  build  a  number  of  dwellings  or 
even  a  town,  complete,  with  its  light,  water  and  drainage 
systems,  schools,  and  system  of  government.  The  United 
States  Steel  Corporation,  for  example,  has  built  sev- 
eral towns;  various  towns  have  been  built  also  some- 
what as  social  experiments,  for  the  business  man  of  the 
larger  type  has  an  insatiable  curiosity  and  a  distinct  tend- 
ency to  take  up  hobbies. 

The  Department  of  Labor  in  191 7  made  an  investi- 
gation of  housing  conditions  in  the  United  States.  A 
summary  of  the  report  was  published  as  a  bulletin  in 
November,  1917.^ 

The  Bureau,  before  beginning  this  investigation,  ob- 
tained a  list  of  over  700  employers  who  have  endeavored 
to  house  their  men;  it  is  estimated  that  if  the  list  had 
been  complete,  it  would  have  contained  fully  1,000 
names. 

^  Employer's  Housing  in  the  United  States,  by  Lei  fur  Magnus- 
son.  Summary  of  a  forthcoming  report  of  the  United  States 
Bureau  of  Labor  Statistics  in  the  United  States. 


THE   CONTROL   OF  LABOR  367 

Of  these  700  firms  or  companies,  213  were  studied; 
these  controlled  423  establishments  or  plants,  employing 
466,991  men,  of  whom  160,645,  or  34  per  cent,  were 
accomodated  in  company  houses,  exclusive  of  boarding 
houses.  Data  are  for  the  year  19 16.  The  investigation 
was  therefore  not  comprehensive,  but  was  representative. 

Some  of  the  outstanding  facts  brought  out  in  the  study 
are  as  follows : 

Town-planning  has  had  little  consideration,  technical 
town-planners  having  been  consulted  in  only  15  per  cent 
of  the  cases.  This  idea  is  of  recent  origin  and  is  used 
more  by  manufacturing  companies  than  by  mining  com- 
panies. Model  towns,  with  few  exceptions,  are  of  recent 
construction. 

Public  utilities  are  provided  and  governmental  func- 
tions exercised  by  companies  themselves  in  the  great 
majority  of  cases. 

The  chief  characteristic  noticeable  in  every  company 
town  is  uniformity — same  type,  of  buildings  and  same 
rectangular  survey. 

Two-thirds  of  the  houses  have  four  to  six  rooms. 
Sixty-nine  per  cent  rent  for  less  than  $8  a  month.  Cost 
ranges  from  $600  to  $1,500,  average  about  $750. 

Maintenance  is  the  most  important  problem.  One- 
third  of  the  companies  encourage  gardening,  which  neces- 
sitates fencing;  it  is  better  for  the  company  to  build 
fences  than  to  leave  that  task  to  the  tenants,  for  they 
will  use  unsightly  material — old  boards,  boxes,  corrugated 
iron  and  waste  wire.  Good  fences  add  much  to  the 
appearance  of  the  town. 

Repairs  are  often  taken  care  of  by  the  regular  com- 


368  PRINCIPLES  OF  BUSINESS 

pany  repair  department,  but  sometimes  a  special  or  sepa- 
rate repair  department  is  maintained. 

As  to  the  housing  investment,  the  work  is  usually  con- 
ducted as  part  of  the  company's  business,  from  the  gen- 
eral office. 

Of  213  cases,  only  13  reported  the  practice  of  con- 
structing and  selling  houses  to  workmen.  One  Ohio  con- 
cern (manufacturing)  which  encourages  ownership  of 
the  house  by  the  workman  sells  the  property  on  an  easy 
payment  at  "real  estate  value,"  a  price  about  25  per  cent 
above  original  cost,  but  when  the  workman  has  kept  up 
his  payments  for  five  years  and  is  still  in  the  employ  of 
the  company  the  difference  is  returned  to  him  and  sub- 
sequent payments  are  made  upon  the  basis  of  actual  cost. 
Other  establishments  sell  lots  to  employees  and  in  each 
case  require  the  erection  of  a  house  within  a  year. 

Cost  of  housing. — Conditions  are,  of  course,  variable, 
but  60  companies  report  their  cost  of  housing,  not  includ- 
ing cost  of  land,  as  $15,948,502.  This  is  28  per  cent  of 
the  average  annual  payroll  of  these  companies,  for  the 
period  1911-1915.  These  houses  accommodated  42  per 
cent  of  their  employees.  If  the  figures  were  correct  for 
present  conditions,  an  employer  wishing  to  house  half 
of  hi'S  employees  would  expect  the  cost  to  be  one-tliird  of 
the  annual  payroll.  In  other  words,  the  investment  re- 
quired, exclusive  of  land,  for  housing  the  average  em- 
ployee, amounts  to  two-thirds  of  the  employee's  annual 
wage. 

Returns  on  the  investment  vary  from  6.2  per  cent,  in 
the  case  of  steel  companies  in  Ohio  and  Pennsylvania,  to 
20  per  cent  in  the  case  of  Alabama  Mining  Companies. 


THE   CONTROL   OF  LABOR  369 

Reasons    for    undertaking    industrial    housing. — 

Among  the  reasons  given  by  employers  for  their  under- 
taking to  house  their  employees,  the  following  are  given 
as  representative:  "It  pays  as  a  business  proposition;" 
"stockholders  were  interested  in  the  real  estate  company 
which  built  the  houses;"  "property  bought  for  plant  ex- 
tension (housing  incidental) ;"  "feehng  that  employer 
owes  something  to  the  men;"  "as  an  experiment;"  *'to 
prove  out  factory  village  plan  as  a  new  theory;"  ''to  pro- 
mote the  general  welfare  of  mankind;"  "to  obtain  a 
supply  of  foreign  labor." 

Results  of  housing  activities. — The  results  reported, 
arranged  in  the  order  of  their  frequency,  are  as  follows : 

1.  Secures  better  class  of  workmen. 

2.  Greater  stability  in  supply  of  labor. 

3.  Reduction  in  number  of  floaters. 

4.  Better  living  conditions. 

5.  Greater  loyalty  of  employees. 

6.  More  contented  and 

7.  More  efficient  workmen. 

8.  Better  control  of  labor  situation — that  is,  hiring  and 
discharging  may  be  done  with  greater  freedom. 

9.  Attracts  married  men. 

10.  Greater  regularity  of  employment. 

11.  Better  house  for  less  money  for  workman. 

12.  Brings  profit  to  the  company. 

13.  Facilitates  part  time. 

14.  Serves  to  advertise  company  and  keep  it  favorably 
before  the  public. 

All  of  the  foregoing  results,  if  they  are  actually  secured, 
are  of  the  greatest  practical  value,  and  it  would  seem  that 


370  PRINCIPLES  OF  BUSINESS 

if  housing  secures  these  results  the  question,  in  cases 
where  conditions  are  suitable,  would  be  not  whether 
or  not  to  house  employees,  but  the  selection  of  the  best 
plan. 

Reviewing  the  history  of  housing  conditions  in  the 
United  States,^  Mr.  John  Ihlder,  Secretary  of  the  Phila- 
delphia Housing  Commission,  concludes  that  better  con- 
ditions must  be  provided — but  that  how,  is  far  from  set- 
tled. We  are  faced  with  the  fact,  he  observes,  that  a 
laisscn  fcdre  policy  is,  in  the  long  run,  unworkable,  and 
we  have  also  the  experience  that  paternalism  is  not  work- 
able. This  is  important  because  the  first  instinct  of  those 
who  have  power,  when  inspired  to  use  that  power  for  the 
benefit  of  others,  is  to  use  it  paternalistically. 

"Employers  agree,"  says  Mr.  Ihlder,  "that  housing  re- 
duces strikes  and  labor  turnover.  That  is  the  business 
end  of  it.  Whether  it  lessens  sickness,  they  do  not  know 
— have  not  thought  much  about  it.  That  it  makes  men 
more  contented,  they  believe." 

It  is  asserted  by  practically  all  employers  reporting  on 
the  subject  that  the  demand  for  houses  far  outruns  the 
supply.  This  would  indicate  that  the  housing  plan 
appeals  to  the  workman  as  well  as  to  the  employer.  As 
a  means  of  reducing  labor  turnover,  then,  the  housing  of 
workmen  is  satisfactory  to  both  employer  and  employee, 
the  various  problems  which  a  housing  undertaking  in  • 
evitably  creates  ought  eventually  to  be  solved — such  prac 
tical  problems  as  those  of  crowding,  or  of  sanitation,  aa 
well  the  less  definite  but  quite  important  question  of  social 
responsibility.  The  essence  of  the  social  problem  is : 
*  American  Academy  of  Political  and  Social  Science,  Annals,  1917. 


THE  CONTROL  OF  LABOR  371 

how  to  control  men  without  taking  away  their  freedom, 
and  it  is  not  the  simplest  problem  in  the  world. 

Why  maintenance  work  in  general  has  been  under- 
taken.— Reasons  that  have  been  given  by  employers  in 
explanation  of  their  interest  in  maintenance  work  have 
been  tabulated  as  follows — the  list  being,  of  course,  far 
from  complete : 

1.  "Pride  in  plant." 

2.  "Personal  interest  in  employees." 

3.  "Social  vision — recognition  of  the  fact  that  it  is  the 
employee's  present  labor  which  is  exchanged  for  wages — 
not  his  future  earning  power." 

4.  "Loyalty  and  co-operation  of  employees  secured." 

5.  "Competition  for  workers  in  labor  scarcity." 

6.  "Offset  to  union  activities — threat  may  be  made  to 
withdraw  benefits." 

7.  "Public  opinion  obtained  in  support  of  company, 
especially  in  the  case  of  public-service  corporations." 

The  present  status  of  maintenance  work. — The  con- 
clusions of  Dr.  Fleisher,  quoted  above,  as  to  these  points 
are,  briefly,  as  follows :  That  maintenance  work  has  un- 
doubtedly gratified  pride  and  has  developed  social  vision, 
but  that  industry  seeks  more  tangible  results,  in  the  form 
of  lowered  production  costs.  The  results  are  difficult, 
however,  of  determination  and  analysis.  The  pioneers 
of  maintenance  work  have  faith  in  it,  and  claim  that  it 
justifies  its  cost  by  stabilizing  the  labor  force.  So  far, 
however,  maintenance  work  has  not  been  of  sufficient  ex- 
tent to  influence  the  community  appreciably,  except  in  iso- 
lated instances.  It  has  a  community  value,  however,  in  the 
fact  that  it  sets  higher  standards  for  industrv  and  raises. 


I'j2  PRINCIPLES  OF  BUSINESS 

the  minimum  set  by  law.  The  work  is  still  too  new  to 
have  been  perfected  by  any  one  organization,  and  before 
it  can  be  regarded  as  being  an  important  factor  in  Ameri- 
can industry,  it  m.ust  be  widely  extended — not  in  all  its 
forms,  but  in  those  which  prove  most  profitable.  In 
order  that  the  work  may  be  so  extended,  two  develop- 
ments are  essential : 

1.  Analysis  of  results,  so  that  it  can  be  demonstrated 
that  maintenance  work  pays. 

2.  Democratization  of  activities,  in  order  to  overcome 
hostility  and  criticism  of  the  workers. 

"Welfare  work,"  says  Dr.  Fleisher,  "has  passed  its 
first  stage — that  of  experiment.  The  second  stage — that 
of  interpretation  and  evolution — is  now  reached.  The 
future  depends  upon  whether  careful  scrutiny  will  prove 
its  value;  if  it  does,  welfare  work  will  be  correlated  to 
successful  management  and  will  enter  upon  its  third, 
stage — that  of  extension  and  expansion." 

BIBLIOGRAPHY 

Hollingsworth  and   Poffenberger,  Applied  Psychology. 

Miinsterberg,   Hugo,  Psychology  and  Industrial  Efficiency. 

Kemble,  W.  F.,  Choosing  Etnployecs  by  Test. 

Taylor,  F.  W.,  Shop  Management. 

Gantt,  H.  L.,  Industrial  Leadership. 

Gantt.  H.  L.,   Work,  Wages  and  Profit. 

Gibbs,  Winifred  Stuart,  The  Minimum  Cost  of  Living. 

Burrit,  Dennison,  Gay,  Heilman  and  Kendall,  Profit  sharing. 

Commons,  John  R.,  History  of  Labor  in  the  United  States. 

Bloomiicld,  Daniel,  Employment  Management. 

Aronovici,   Carol,   Housing  and  the   Housing  Problem. 

Bloomfield,    Daniel,    Modern    Industrial    Movements. 

Bloorafield,  Daniel,  Problems  of  Labor. 

Colvin,  J.  H.,  Turnover,  Loyalty  and  Output. 

American  Academy  of  Political  and  Social  Science,  Industrial 
Stability.  The  Annals  of  the  Academy  for  July,  1920,  Vol.  XC,  No. 
179. 


CHAPTER    XVII 

PURCHASING 

The  purchasing  agent's  place  in  the  business  or- 
ganization.— The  importance  of  the  purchasing  agent 
and  his  opportunities  for  service  to  the  business  organ- 
ization are  only  beginning  to  be  recognized.  The  duties 
of  the  purchasing  agent's  office  call  for  abilities  of  the 
very  highest  order — of  an  order  so  high  that  several 
duties  which  logically  pertain  to  the  office  of  the  purchas- 
ing agent  have  been  assumed  by  the  general  manager  and 
the  heads  of  various  departments.  This  is  for  the  rea- 
son that,  generally  speaking,  the  purchasing  agent  has 
not  realized  the  possibilities  of  his  position  and  has  not 
capitalized  his  assets.  It  rests  with  the  purchasing  agent 
himself  whether  he  shall  be  'merely  a  "rubber  stamp"  or 
whether  he  shall  raise  his  office  to  a  dignity  and  im- 
portance second  only  to  that  of  the  office  of  the  general 
manager. 

The  scope  of  the  purchasing  agent's  authority. — • 
Neither  the  purchasing  agent  nor  any  other  official  under 
the  general  manager,  of  course,  can  have  an  independent 
power  in  the  organization,  else  the  essential  unity  of 
command  would  be  destroyed.  The  purchasing  agent's 
duties  should  be  executive  with  respect  to  the  exercise  of 
his  special  function — purchasing — but  advisory  with  re- 
spect to  the  formation  of  the  policies  and  plans  of  the 
business.     In  the  business  organization,  however,  recom- 

373 


374  PRINCIPLES  OF  BUSINESS 

mendations  have  the  practical  force  of  decisions  in  a  de- 
gree corresponding  to  the  degree  of  knowledge  and  sound 
judgment  possessed  by  the  person  who  makes  the  recom- 
mendation. 

The  purchasing  agent  should  rank  with  the  sales 
manager. — Let  us  compare,  for  example,  the  position  of 
the  purchasing  agent  with  that  of  the  sales  manager. 
The  business  enterprise  stands  midway  between  supply 
and  demand.  The  sales  manager  correlates  the  organiza- 
tion with  demand,  the  purchasing  agent  correlates  it  with 
supply.  Each  of  these  functions  is  of  vital  importance 
and  should  be  regarded  as  being  of  equal  rank. 

The  sales  manager  is  like  a  horse  groomed  for  the  race. 
He  carries  with  him  the  hopes  and  fortunes  of  the  or- 
ganization. There  is  little  knowledge  or  skill,  however, 
which  the  sales  manager  is  expected  to  possess  which  is 
not  or  should  not  be  possessed  in  equal  or  even  greater 
degree  by  the  purchasing  agent. 

The  sales  manager  must  know  the  products  of  the 
house,  and  know  them  thoroughly.  The  purchasing 
agent  does  not  have  to  go  out  of  his  way  to  get  this  in- 
formation, as  does  the  sales  manager.  He  has  purchased 
every  item  of  material  that  has  entered  into  the  product, 
and  usually  knows  the  product  as  the  salesman  seldom 
can  know  it. 

The  sales  manager  must  be  a  student  of  business  con- 
ditions and  market  movements.  Not  less  must  the  pur- 
chasing agent.  The  salesman  must  analyze  and  interpret 
the  records  of  the  business.  So  must  the  purchasing 
agent.  The  sales  manager  must  be  a  psychologist,  not 
only  by  training  but  by  intuition,  knowing  how  by  the 


PURCHASING  375 

use  of  argument  and  suggestion  and  the  whole  force  of 
his  psychic  being  to  clash  with  the  will  of  his  opponent 
and  overcome  it.  His  antagonist  in  such  an  encounter 
is  more  than  likely  to  be  the  purchasing  agent  of  some 
T)ther  business  organization,  and  in  all  these  things  this 
purchasing  agent  must  match  him — if  he  is  a  purchasing 
igent  and  not  a  "rubber  stamp." 

Opportunities  open  to  the  purchasing  agent. — ■ 
^Vithout  belittling  in  any  way  the  office  of  the  salesman 
or  the  sales  manager,  there  are  many  opportunities  for 
service  and  consequently  for  place  and  power  open  to 
the  purchasing  agent  which  are  not  open  to  the  sales 
manager.  We  do  not  maintain  that  the  purchasing  agent 
of  the  typical  business  organization  has  recognized  and 
taken  advantage  of  these  opportunities.  The  functions 
which  properly  belong  to  the  purchasing  agent,  as  noted 
above,  have  been  delegated  to  various  heads  of  depart- 
ments, leaving  the  purchasing  agent  circumscribed  in 
authority  and  range  of  activity.  The  hope  of  the  pur- 
chasing agent  lies  in  his  fitting  himself  to  assume  his 
proper  functions  and  in  demonstrating  that  they  are 
rightfully  his.  What  these  functions  are  we  shall  indi- 
cate briefly  in  the  following  pages. 

Ability  and  opportunity  to  acquire  knowledge  and 
to  use  it  is  the  "secret"  of  power. — The  importance  of 
the  position  which  any  official  holds  in  a  business  organ- 
ization depends  upon  his  opportunities  for  acquiring 
knowledge  valuable  to  the  business,  his  opportunities  for 
applying  that  knowledge  to  the  actual  operation  of  the 
business,  and  the  use  which  he  personally  makes  of  these 
opportunities.     If  the  truth  of  this  premise  be  granted, 


376  PRINCIPLES  OF  BUSINESS 

let  us  see  what  the  opportunities  are  which  are  open  to 
the  purchasing  agent. 

The  purchasing  agent  learns  the  methods  and  proc- 
esses of  other  business. — In  the  first  place,  there  is 
no  official  connected  with  the  business  organization  who 
has  a  better  chance  than  has  the  purchasing  agent  to 
learn  of  the  "inside  workings"  of  other  business  enter- 
prises— especially  of  their  production  departments.  In 
the  case  of  each  item  of  material  or  supplies  bought  by 
the  purchasing  agent,  he  is  expected  to  familiarize  him- 
self with  all  the  essential  processes  of  its  manufacture. 
The  merits  of  the  various  processes  employed  by  rival 
establishments  are  explained  to  and  impressed  upon  the 
purchasing  agent  by  the  salesmen  of  the  competing 
houses.  He  himself  inspects  the  plants  of  the  vendors 
with  whom  he  makes  important  contracts  and  employs 
production  specialists  to  analyze  their  facilities  and  re- 
port upon  the  effectiveness  of  their  methods.  He  gets 
the  detail  of  the  various  processes.  He  is  in  a  position, 
therefore,  to  judge  of  the  relative  advantages  of  the  vari- 
ous processes  or  methods  of  manufacture  and  should  be 
in  a  position  to  influence  the  methods  of  his  own  estab- 
lishment in  so  far  as  the  knowledge  he  gains  is  relevant 
and  applicable.  Obviously,  the  purchasing  agent  who 
makes  use  of  the  opportunity  touched  upon  above  should 
occupy  a  place  in  the  highest  councils  of  the  production 
department. 

The  purchasing  agent  becomes  a  market  analyst, 
concerned  with  both  supply  and  demand. — Taking  at 
random  another  illustration,  the  course  of  the  businese 
enterprise  is  determined  by  the  interaction  of  demand  and 


PURCHASING  S77 

supply  as  this  interaction  is  interpreted  by  those  in  con- 
trol of  the  enterprise.  Now  the  sales  manager,  who  is 
admittedly  one  of  the  "powers  that  be,"  is  concerned,  in 
the  exercise  of  his  function  of  selling,  chiefly  with  de- 
mand, which  is  only  one  of  the  factors.  He  is  interested 
in  supply  as  well,  but  he  has  to  go  out  of  his  way,  so  to 
speak,  to  get  the  information  he  needs  concerning  supply. 
The  purchasing  agent,  however,  in  the  course  of  his  regu- 
lar duties,  has  a  knowledge  of  both  demand  and  supply 
absolutely  forced  upon  him.  He  must  be  as  keen  a 
market  analyst  as  the  sales  manager  himself,  not  only 
from  the  selling  point  of  view  but  from  the  buying  point 
of  view.  H  he  takes  advantage  of  the  opportunity  he 
has  to  interpret  the  interaction  of  supply  and  demand  as 
reflected  in  the  trend  of  prices  and  business  conditions 
generally,  he  should  have  as  much  influence  as  any  other 
official  under  the  general  manager,  in  the  determination 
of  the  larger  policies  of  the  business. 

The  purchasing  agent  deals  with  many  products 
and  in  many  markets. — Again,  there  is  no  other  official 
in  the  organization  who  has  the  opportunity  to  observe 
business  conditions  from  so  many  angles — for  the  reason 
that  the  other  officials — those  of  the  sales  department, 
for  example,  who  also  come  in  direct  contact  with  the 
outside  bvisiness  world — are  concerned  directly  with  only 
the  relatively  few  classes  of  products  which  they  sell. 
The  purchasing  agent,  however,  is  directly  concerned 
with  the  many  lines  that  enter  into  each  article  produced 
for  sale.  Where  the  salesman  sells  an  automobile,  for 
example,  he  sells  a  single  article — an  automobile.  The 
purchasing  agent  as  against  the  salesman's  one  article, 


378  PRINCIPLES  OF  BUSINESS 

deals  with  a  hundred  articles  or  classes  of  material — 
wood,  steel,  copper,  tin,  rubber,  leather,  cotton,  wool  and 
innumerable  other  materials  and  parts.  With  respect  to 
each  article  or  material  purchased  he  must  know  the  trend 
of  prices  and  the  stocks  in  the  hands  of  dealers.  He 
must  know  offhand  the  condition  of  the  steel  companies 
in  regard  to  their  unfilled  orders;  he  should  know 
whether  or  not  it  has  rained  since  yesterday  in  the  cotton 
belt;  and  what  the  outlook  is  for  shipments  of  rubber 
from  South  America.  If  he  has  this  knowledge,  and 
other  knowledge  of  a  similar  nature,  he  might  well  be 
looked  to  for  guidance  in  the  determination  of  the  manu- 
facturing and  marketing  policies  of  the  business. 

Opportunities  of  the  purchasing  agent  to  introduce 
cheaper  and  more  serviceable  materials. — It  is  not 
only  in  the  formation  of  general  policies  that  the  pur- 
chasing agent  can  render  a  direct  service  to  the  organiza- 
tion, in  addition  to  the  service  he  renders  in  the  actual 
purchasing  of  materials  and  supplies.  The  saving  which 
he  may  effect  by  purchasing  efficiently  may  be  taken  for 
granted — of  this  we  shall  have  something  to  say  later  in 
the  chapter.  Many  opportunities  exist,  however,  for  the 
discovery  by  the  purchasing  agent  of  cheaper  or  more 
serviceable  materials  or  supplies  for  use  in  the  manufac- 
turing and  other  departments.  The  adoption  of  certain 
materials  of  certain  specifications  for  regular  use  in  cer- 
tain processes  is  called  standardization.  Standardiza- 
tion is  accomplished  by  the  adoption  of  the  specifications 
recommended  by  the  engineering  or  other  experimental 
departments,  in  view  of  various  market  and  other  con- 
siderations apparent  to  the  management.     Information 


PURCHASING  379 

as  to  market  conditions — of  the  sources  of  supply — is 
essential  in  intelligent  standardization.  The  information 
of  this  nature  contributed  by  an  alert  purchasing  agent  is 
of  inestimable  value.  This  point,  however,  must  also 
be  considered :  The  engineering  department,  we  may 
assume,  has  for  its  primary  object  the  combination  of  the 
elements  which  enter  into  a  product  which  will  give  the 
ideal  result,  regardless  of  price — that  is,  price  is  not  a 
primary  consideration  in  the  minds  of  the  engineers  or 
chemists.  But  the  purchasing  agent  is  directly  and  ac- 
tively concerned  with  price.  With  his  wide  range  of 
observation  and  his  knowledge  of  many  things  which 
will  escape  the  specialists  of  the  laboratory,  he  should 
co-operate  continually  with  these  specialists  in  a  search 
for  cheaper  but  equally  satisfactory  products  or  grades 
of  material  which  can  be  used  in  place  of  the  more  ex- 
pensive. The  purchasing  agent  is  actually  able  to  accom- 
plish much  along  this  line,  for  the  reason  that  being  ad- 
mittedly an  authority  on  sources  of  supply  and  admittedly 
familiar  with  everyday  practice  both  in  his  own  estab- 
lishment and  in  many  other  establishments,  he  is  not 
looked  upon  as  an  amateur,  but  is  given  the  right  to  sug- 
gest improvements — a  right  which  is  properly  withheld 
from  those  who  have  not  mastered  the  methods  pre- 
viously in  use.  The  purchasing  agent,  accordingly,  has 
the  unique  opportunity  of  introducing  improvements  in 
materials  and  processes — subject,  of  course,  to  the  ap- 
proval of  the  department  authority — and  to  the  extent  to 
which  he  avails  himself  of  this  opportunity  he  will  bene- 
fit the  business  and  establish  himself  in  a  higher  as  well 
as  more  lucrative  position. 


38o  PRINCIPLES  OF  BUSINESS 

The  purchasing  agent's  service  to  the  country,  in 
the  conservation  of  resources. — In  these  days,  more- 
over, of  shortage  of  essential  goods,  the  purchasing  agent 
can  perform  a  pubHc  service  by  conserving  the  articles 
in  which  the  most  serious  shortage  exists,  by  using  sub- 
stitutes for  these  wherever  possible,  by  refusing  to  hoard 
material  that  the  country  at  large  is  in  need  of  and  in 
many  other  ways.  Further  than  this,  he  can  increase  the 
industrial  capacity  of  the  country  by  promoting  better 
business  methods  and  by  striving  to  standardize  the  best 
methods  in  the  ])ractice  of  the  business  community. 

His  work  in  the  standardization  of  contracts  and  terms 
of  sale  should  go  far  toward  eliminating  the  lack  of  uni- 
formity that  has  hitherto  obtained.  In  the  furthering  of 
the  adoption  of  uniform  practice  with  respect  to  credit 
matters,  particularly  with  respect  to  the  trade  acceptance, 
his  efforts  are  the  logical  complement  of  the  efforts  of 
the  credit  men  of  the  country  in  the  same  direction — ^the 
one  represents  the  seller — the  other,  the  buyer. 

Unfortunately,  in  too  many  instances  the  purchasing 
agent  has  had  little  or  no  incentive  to  concern  himself 
with  the  management  functions  of  the  business  enter- 
prise. Before  the  European  War,  when  the  purchasing 
department  came  into  existence  as  a  subdivision  of  the 
accounting  department,  it  was  generally  assumed  that 
almost  anyone  could  purchase — that  the  only  important 
part  of  business  was  selling!  The  curtailed  supplies  re- 
sulting from  the  prior  claims  of  the  war  gave  a  new 
importance  to  the  purchasing  agent.  Selling  remains  im- 
portant, but  for  the  same  reason  purchasing  needs  expert 
attention.     It  is  certain,  however,  that  buying  will  con- 


PURCHASING  381 

tinue  to  increase  in  its  recognized  importance.  If  there 
are  many  sellers  again,  and  many  products  to  choose 
from,  it  will  be  recognized  that  buying  is  not  thereby 
made  easier,  but  in  reality  more  difficult,  offering  more 
opportunities  for  the  exercise  of  the  buyer's  fullest 
powers. 

In  the  following  outline  of  present-day  business  prac- 
tice in  the  operation  of  a  purchasing  department,  the 
position  of  the  purchasing  agent  as  therein  set  forth  is  far 
from  that  which  the  importance  of  his  position  demands, 
and  far  from  that  which  it  is  likely  to  be  in  the  future — 
when  the  purchasing  agent  will  have  become  aware  of 
his  opportunities  and  will  have  taken  advantage  of  them. 
If  the  purchasing  agent  would  occupy,  as  he  may,  one  of 
the  very  highest  places  in  the  business  organization — in 
other  words,  if  he  would  capitalize  his  assets — let  him  be- 
gin by  classifying  and  organizing  the  data  he  secures  in 
the  course  of  his  everyday  duties,  with  a  view  to  putting 
this  knowledge  into  actual  use  in  the  organization. 

The  purchasing  department.^ — -The  chart  shown  here- 
with indicates  the  duties  the  perforniance  of  which  comes 
under  the  supervision  of  the  purchasing  agent. 

The  purchasing  department  is  a  subdivision  of  the  pro- 
duction department,  and  is  co-ordinate  with,  not  subsid- 
iary to,  the  manufacturing  department.  It  is  true  that  in 
some  respects  the  purchasing  department  is  under  control 
of  the  works  manager.  The  purchasing  agent  buys 
upon  requisitions  and  specifications  made  out  by  the 
manufacturing  department,  but  he  is  accountable  not  to 
the  works  manager,  but  to  the  comptroller  or  to  the  vice- 
president  in  charge  of  production. 


382 


PRINCIPLES  OF  BUSINESS 


The  specific  duties  of  the  purchasing  agent,  as  head 
of  his  department,  are  to  assemble  purchasing  data,  to 
place  orders  for  supplies  as  they  are  requisitioned,  and 
to  secure  delivery  within  the  time  specified  upon  the  pur- 
chase requisitions. 


<^"°""°"'     i         |pu'c"°a«0.<. 


D 


-^Si^ — 

Complaints 


X 


I     Checking        ] 


Reponi 
Covering 
Receipts 


ORGANIZATION  OF  PURCHASING   DEPARTMENT 
DETAILED   ORGANIZATION   OF  THE   PURCHASING    DEPARTMENT 

(From   Knoeppel's   Organization  and  Management) 

Analysis  of  purchase  requirements. — At  intervals 
during  the  year,  purchase  requirements  will  be  analyzed 
and  a  buying  program  drawn  up.  In  the  analysis  of  pur- 
chase requirements  the  sales  department  plays  a  very  im- 
portant part — furnishing  much  of  the  data  by  which  the 
character  and  amount  of  the  goods  to  be  purchased  will 
be  determined.  The  recommendations  of  the  sales  de- 
partment will  be  modified  by  the  recommendations  of  the 
purchasing  agent,  since  it  is  from  him  that  inforrriation 
must  be  obtained  as  to  the  materials  and  supplies  which 
can  be  obtained  and  as  to  the  probable  cost  of  these  ma- 
terials and  supplies.     In  the  chapters  on  "Selling"  will  be 


PURCHASING  383 

found  an  outline  of  the  procedure  in  market  analysis. 
The  records  supplied  by  the  accounting  department  will 
also  be  taken  into  consideration,  just  as  they  are  taken 
into  consideration  in  mapping  out  the  selling  program. 

Standardization  of  purchases. — When  the  classes  of 
materials  and  supplies  and  the  quantities  of  each  class 
are  decided  upon,  maximum  and  minimum  limits  will  be 
fixed,  wherever  possible.  Since  the  purchasing  agent  is 
required  to  provide  the  articles  to  be  purchased  at  the 
time  when  they  are  needed,  it  is  argued  that  the  purchas- 
ing agent  should  fix  the  maximum  and  minimum  amounts 
to  be  kept  in  stock — his  knowledge  of  market  conditions 
fitting  him  for  this  duty.  The  planning  department, 
however,  usually  fixes  the  limits  held  to  be  advisable, 
since  the  planning  department  has  the  best  facilities  for 
forecasting  the  need  for  each  class  of  goods. 

Standardization  includes  not  only  the  fixing  of  the 
class  and  of  the  quantity,  but  also  of  the  exact  quality  to 
be  incorporated  in  the  supplies  purchased.  Chemical  and 
physical  laboratories  are  maintained  for  experimental 
work  and  for  testing  the  materials  purchased,  in  order  to 
determine  whether  or  not  they  conform  to  the  standards 
which  have  been  fixed.  As  noted  above,  the  purchasing 
agent  should  keep  in  close  touch  with  the  laboratory  ex- 
perts and  obtain  their  help  in  the  discovery  or  adaptation 
of  materials  the  use  of  which  will  effect  a  saving  in  cost. 

Some  of  the  large  corporations  of  the  country  maintain 
laboratories  at  a  cost  of  as  much  as  a  million  dollars  a 
year.  Smaller  concerns  sometimes  co-operate  in  the  up- 
keep of  a  joint  laboratory. 

Schedules  of  delivery. — In  a  well-systematized  estab- 


384  PRINCIPLES  OF  BUSINESS 

lishment  tlae  delivery  schedules  may  call  for  delivery  from 
time  to  time  of  certain  goods  not  only  upon  the  days 
specified  but  at  certain  hours,  and  at  specified  warehouse 
or  shop  doors.  Where  the  requirements  can  be  prede- 
termined so  accurately  as  to  make  such  a  delivery  sched- 
ule possible,  a  considerable  saving  may  be  effected  with 
respect  to  investment  in  stock  as  well  as  in  the  cost  of 
storing  and  rehandling  the  goods.  It  is  unsafe,  of 
course,  to  institute  such  close  delivery  schedules  except 
in  dealings  with  vendors  of  unquestionable  responsibility. 

Where  materials  under  such  a  delivery  schedule  are 
delivered  directly  to  the  shops  or  the  "jobs"  in  which 
they  are  to  be  used,  they  do  not  pass  through  the  per- 
petual inventory  records  of  the  stores  department  but  are 
charged  immediately  to  the  "work  in  process"  or  other 
similar  account.  From  the  accounting  standpoint  this  is 
an  objection  to  the  system  referred  to,  but  this  disadvan- 
tage may  be  more  than  offset  by  the  saving  in  storage  and 
handling. 

The  sources  of  supply. — One  of  the  most  important 
duties  of  the  purchasing  agent  is  the  keeping  of  a  list  of 
^'vendors  and  their  wares." 

Such  a  list  is  compiled  from  data  gathered  from  many 
sources.  The  sources  may  include :  Advertisements ; 
catalogues  and  circulars  received ;  articles  in  trade  jour- 
nals; manufacturers'  directories;  telephone  directories; 
membership  lists  of  trade  associations,  and  other  sources 
of  a  like  nature.  The  purchasing  agent  will  add  to  his 
list,  of  course,  the  names  of  all  who  answer  his  adver- 
tisements for  bids  and  other  advertisements,  as  well  as 
the  names  of  those  whom  he  may  meet  at  conventions 


PURCHASING  t        385 

and  elsewhere,  and  will  also  get  useful  information  from 
salesmen  and  others  who  are  in  touch  with  the  markets. 

It  is  well  for  the  purchasing  agent  to  keep  as  closely 
in  touch  with  vendors  as  is  reasonably  possible,  whether 
or  not  any  purchases  are  made  from  them.  Quotations 
should  be  asked  for,  and  the  vendor  reminded  that  his 
name  is  on  the  purchasing  agent's  list.  A  courteous 
reply  should  be  made  to  every  letter,  and  it  should  be  re- 
membered that  where  personal  interviews  do  not  take 
place,  the  impression  made  by  tke  house  is  no  more  than 
that  conveyed  by  the  letter.  No  detail  is  so  small  that  it 
may  be  disregarded.  The  letterhead,  the  quality  of  the 
paper,  the  style,  the  typing,  the  legibility  of  the  signature, 
all  will  be  noted  by  the  reader.  An  unfavorable  impres- 
sion created  by  any  of  these  will  be  difficult  to  eradicate. 

The  mere  possession  of  a  list  of  vendors  and  their 
wares  would  be  insufficient  for  the  purposes  of  the  pur- 
chasing agent.  He  must  know  as  much  as  possible  about 
the  various  manufacturers  and  dealers — where  their  dis- 
tributing stations  are  located,  the  freight  rates  and  ship- 
ping facilities,  the  capacity  of  tfieir  plants,  the  amount  of 
goods  th,ey  keep  in  stock,  the  quality  of  the  goods,  the 
quotations  that  may  be  expected,  and  the  reputation  of 
the  house.  Careful  records  will  be  kept  of  dealings  with 
vendors,  so  that  reference  cai*-be  made  to  prices  and  serv- 
ice obtained  from  each  in  the  past.  Especially  when 
large  orders  are  to  be  given,  the  purchasing  agent  will 
assure  himself  of  the  comi>etence  of  the  vendor  to  make 
delivery.  If  h»  is  not  thoroughly  satisfied  as  to  the 
ability  of  the  vendor  to  comply  with  his  contract  he  may 
visit  the  vendors  plant  in  order  to  make  a  personal  esti- 


386         •       PRINCIPLES  OF  BUSINESS 

mate  of  its  capacity,  or  he  may  employ  a  firm  of  produc- 
tion engineers  to  make  a  report  upon  the  matter. 

A  supply  of  goods  or  material  is  fundamental  in  the 
operation  of  any  business  establishment,  whether  manu- 
facturing or  mercantile,  and  no  chances  must  be  taken  of 
a  failure  of  the  supply.  A  shortage,  of  course,  will  tie 
up  the  plant.  An  excess  over  requirements  will  cause 
needless  investment  and  storage  costs.  It  is  necessary, 
therefore,  to  estimate  the  requirements  carefully  and  to 
let  contracts  only  to  vendors  who  are  able  to  comply  in 
detail  with  the  terms  of  the  contract.  Delivery  is  usually 
more  important  than  price. 

Purchase  requisitions. — The  purchase  requisition  is 
the  order  to  purchase,  delivered  by  the  stores  department 
or  by  a  designated  authority  in  the  manufacturing  or 
other  department.  The  purchasing  agent  must  be  given 
a  list  of  all  the  officials  who  have  authority  to  make  out 
purchase  requisitions,  and,  of  course,  must  purchase  only 
upon  requisitions  signed  by  a  designated  authority,  in 
order  that  the  buying  program  may  not  be  disarranged. 
In  each  case,  moreover,  the  class  of  goods  which  the 
various  officials  have  the  right  to  requisition  must  be 
specified.  In  like  manner  the  quantities  within  given 
periods  which  each  official  or  department  may  requisition 
may  be  limited,  and  limitations  may  be  put  also  upon  the 
grade  or  quality  of  the  goods  ordered.  This  latter  point 
should  be  taken  care  of  by  standardization,  as  explained 
above. 

With  respect  to  certain  classes  of  goods,  the  purchas- 
ing agent  may  be  required  to  advertise  for  bids ;  in  other 
cases  he  may  buy  under  the  bargaining  system. 


PURCHASING 


387 


It  is  often  required  that  purchase  requisitions  be  made 
only  on  standard  forms.  A  typical  form  is  shown  here- 
with.    (Description  column  disproportionately  reduced.) 


Purchase  Requisiiion 

N2.._ 

Tc 

►        __ .            _.                    -            w                    

J9L-.. 

P 

(Purchasing-AgenO 
lease  order  the  following' articles: 

For  the 
DepL.' 

use  or 

Order  N? 

Quantity 

DescripLion 

Date 
Wanted 

Date 
Ordered 

Purchase 
Order  N2 

ApprOVedCSupt  or  other  authority)  Si^ned(^wc?.sp^^^^ 

1 

PURCHASE    REQUISITION 


The  purchase  requisition,  as  will  be  observed,  should 
show,  as  essential  data,  its  number;  the  date;  the  article 
and  its  specifications ;  the  quantity ;  the  time  within  which 
delivery  must  be  made;  the  signature  of  the  person  mak- 
ing  the  requisition  and  the  signature  of  the  official  by 
whom  the  requisition  is  approved. 

The  limits  of  authority  as  between  the  various  depart- 
ments must  be  clearly  defined.  In  general,  the  planning 
department,  which  makes  out  the  purchase  requisitions, 
is  held  responsible  for  the  correctness  of  the  orders  to 
purchase,  while  the  purchasing  department  is  held  re- 
sponsible for  delivery.  The  purchasing  agent  must  keep 
the  planning  or  manufacturing  department  informed  as 


388  PRINCIPLES  OF  BUSINESS 

to  outside  conditions  and  must  specify  the  time,  with  re- 
spect to  each  article,  which  will  be  required  for  delivery. 
If  the  requisition  made  out  by  the  planning  department 
specifies  a  time  shorter  than  that  which  has  been  desig- 
nated by  the  purchasing  agent,  the  blame  of  a  late  deliv- 
ery falls,  of  course,  upon  the  planning  department. 
Where  purchases  are  standardized,  with  maximum  and 
minimum  amounts  to  be  kept  in  stock,  the  purchase  requi- 
sition is  usually  made  out  by  the  stores  clerk  and  approved 
by  the  superintendent  or  other  authorized  official  of  the 
department  which  will  use  the  goods  in  question. 

Purchasing  methods. — The  first  object  in  purchasing 
is  to  secure  the  goods  needed,  at  the  time  when  they  are 
needed.  The  second  object  is  to  secure  them  at  the  low- 
est price  or  upon  the  most  favorable  terms.  It  may  be 
noted  here,  that  the  purchasing  agent  makes  his  pur- 
chases on  a  basis  of  the  utility  of  the  goods  and  not 
merely  by  weight  or  quantity.  Coal,  for  example,  may 
be  purchased  by  calories  instead  of  by  tons,  and  gas  on 
the  basis  of  British  Thermal  Units  instead  of  merely  cubic 
feet.  The  practical  importance  of  the  distinction  be- 
tween utility  and  mere  quantity  may  be  appreciated  by 
anyone  who  has  noticed  how  little  light  could  be  had 
during  the  time  of  the  war,  when  toluol  was  washed  out 
of  the  gas  for  munitions  purposes,  leaving  the  gas  re- 
duced in  lighting  value  by  some  20  per  cent,  while  the 
consumer  still  paid  the  same  price  per  cubic  foot. 

Within  reasonable  limits,  at  any  rate,  insisting  upon 
the  lowest  price  has  a  sound  justification  from  the  eco- 
nomic standpoint.  While  at  first  thought  it  might  seem 
that  it  should  make  little   or  no  difference  to   society 


PURCHASING  389 

whether  the  one  or  the  other  of  the  parties  to  the  trans- 
action obtained  the  advantage,  it  must  be  noted  that  when 
goods  are  bought  consistently  at  the  lowest  possible  price 
which  leaves  the  seller  a  reasonable  profit,  the  incapable 
or  unfavorably  situated  dealers  are  forced  out  of  busi- 
ness, leaving  production  in  the  hands  of  those  who  are 
able  to  carr}^  on  its  processes  with  the  least  amount  of 
waste.  Reducing  the  dealer's  margin  of  profit,  more- 
over, forces  him  continually  to  devise  and  put  into  prac- 
tice improved  methods,  resulting  obviously  in  a  general 
economic  gain. 

In  general,  there  are  two  methods  or  systems  of  pur- 
chasing: (i)  the  bargaining  method,  (2)  and  the  com- 
petitive system — in  which  bids  are  advertised  for  and 
the  order  given  to  the  lowest  bidder  or  to  the  one  whose 
goods  and  service,  in  connection  with  his  price,  are  con- 
sidered the  best. 

Buying  by  specifications. — In  either  of  these  systems 
purchases  may  and  should  be  made  "on  specification,"  the 
specifications  being  the  detailed  description  of  the  goods 
required.  Certain  classes  of  goods  will  usually  be  bought 
on  the  seller's  specifications,  the  seller  giving  the  buyer  a 
complete  description  of  the  goods  and  guaranteeing  them 
to  conform  to  the  specifications. 

It  is  probable  that  most  of  the  goods  purchased  by  a 
merchandising  establishment  are  bought  on  seller's  speci- 
fications. A  manufacturing  establishment,  however,  will 
usually  draw  up  its  own  specifications,  to  which  the  seller 
must  make  his  product  conform.  It  may  be  noted  that 
buyer's  specifications,  from  one  side  of  the  contract,  are 
seller's  specifications,  from  the  opposite  point  of  view. 


390  PRINCIPLES  OF  BUSINESS 

The  specifications,  obviously,  should  cover  all  essen- 
tial points,  but  beyond  the  essential  points  a  too  minute 
and  rigid  set  of  specifications  involves,  as  a  rule,  an  extra 
cost  of  production  and  also  eliminates  various  sources  of 
supply.  Demand  remaining  the  same  and  supply  being 
decreased,  a  higher  price  inevitably  results.  The  buyer 
must  decide  at  what  point  further  detail  in  the  specifica- 
tions ceases  to  increase  the  value  of  the  product  suffi- 
ciently to  offset  the  increase  in  price. 

Standard  specifications. — Where  goods  or  materials 
are  used  in  large  quantities  it  is  advisable  to  standardize 
the  specifications  and  to  standardize  the  materials  or  sup- 
plies used  throughout  the  establishment.  Care  should  be 
used  to  create  no  unnecessary  classifications.  Goods 
may  then  be  purchased  in  larger  quantities,  at  lower 
prices.  There  will  be  a  saving  also  in  the  cost  of  han- 
dling, and  in  the  case  of  machinery  or  other  equipment,  in 
the  cost  or  repairs  and  upkeep. 

Standardization  also  facilitates  purchasing,  in  that  the 
vendor  who  has  once  filled  an  order  and  recorded  the 
specifications  is  presumably  in  a  position  readily  to  fill 
future  orders  of  the  same  kind.  Planning  does  not  have 
to  be  done  over  again  and  the  chance  of  misunderstanding 
is  lessened.  Time  is  also  saved,  for  the  goods  may  be 
ordered  by  wire.  The  specifications  already  in  the  pos- 
session of  the  vendor,  identified  by  the  order  number, 
enable  him  at  once  to  notify  the  buyer  whether  or  not  he 
can  make  delivery,  and  within  what  time. 

Bargaining. — Bargaining,  while  still  a  prominent  fea- 
ture of  business  in  its  present  stage,  is  gradually  being  dis- 
placed by  one-price  policies  in  connection  with  standard- 


PURCHASING  391 

ization.  Bargaining  in  moderation  perhaps  adds  a  zest 
to  business  dealings ;  in  its  extreme  it  becomes  ridiculous, 
as  in  the  case  of  the  ultimo  preoio  of  Mexico.  The  seller 
asks  a  high  price,  the  buyer  others  a  low  price,  and  finally 
an  intermediate  price — the  ultimo  precio  or  "final  price" 
• — is  agreed  upon.  So  it  is  with  the  buyer  who  habitually 
resorts  to  bargaining  in  his  dealings  with  salesmen.  The 
salesmen  quickly  learn  to  expect  a  "beating  down"  of  the 
price  by  the  buyer,  and  accordingly,  fix  the  original  price 
at  a  point  which  allows  a  safe  margin  for  concessions. 
The  buyer  should  be  "posted"  on  the  cost  of  production 
and  the  fair  price  of  the  classes  of  goods  which  he  buys. 
If  then  the  seller's  price  is  too  high  he  has  a  reasonable 
basis  upon  which  to  demand  a  reduction.  He  may  de- 
liver to  the  salesman  an  "ultimatum/'  with  a  time  limit 
stated  within  which  the  salesman  may  agree  to  his  terms, 
but  he  should  in  such  a  case  be  sure  of  his  ground,  and 
should  mean  and  "stick  to"  what  he  says.  The  policy  of 
wearing  out  the  salesman  by  a  preliminary  "rough-han- 
dling" by  subordinates  may  sometimes  result  in  the  secur- 
ing of  the  goods  at  a  low  price,  but  what  is  saved  in  price 
is  likely  to  be  lost  in  service  and  good-will.  The  real 
value  of  the  efficient  purchasing  agent  is  in  his  knowing 
when  and  where  to  buy,  rather  than  in  his  ability  to  drive 
a  hard  bargain.  He  should  scrutinize  the  market  con- 
tinually in  order  to  discover  upward  or  downward  tenden- 
cies of  prices  of  the  various  commodities  in  which  he  is 
interested,  and  should  ascertain,  if  possible,  not  only  the 
directions  of  price  changes  but  also  the  causes.  The 
most  satisfactory  means  of  visualizing  price  fluctuations 
is  by  the  construction   of   "price   charts,"    which   show 


392  PRINCIPLES  OF  BUSINESS 

month  by  month  and  year  by  year  the  price  paici,  quanti- 
ties purchased,  and  cjuotations  received.  Such  a  study 
of  market  conditions,  besides  aiding  the  purchasing  agent 
in  his  actual  placing  of  orders,  enables  him  to  supply 
authentic  information  to  the  cost  chief,  who  must  be 
guided  in  the  preparation  of  his  estimate-sheets  solely 
by  the  judgment  of  the  purchasing  agent.  The  cost- 
sheet  is  based  upon  the  prices  which  actually  have  been 
paid,  but  the  estimate-sheet  is  based  upon  the  purchasing 
agent's  opinion  as  to  the  market  price  of  the  materials 
included  in  the  estimate  at  the  time  the  estimate  is  made, 
or  in  some  cases,  as  of  the  date  when  the  order  is  to  be 
filled. 

Terms. — The  terms  upon  which  a  purchase  can  be 
made  may  be  as  important  as  the  price,  or  more  so.  In 
the  case  of  a  business  which  has  sufficient  capital  and 
which  is  able  always  to  pay  cash  or  its  equivalent,  the 
terms  of  service  or  delivery  are  of  primary  interest.  If, 
however,  there  is  a  shortage  of  ready  money  in  the 
business,  it  may  be  possible  at  the  sacrifice  of  price  to 
secure  terms  of  payment  which  will  enable  the  purchaser 
to  resell  the  goods  and  pay  for  them  out  of  the  proceeds, 
or  to  install  machinery  on  a  partial  payment  plan  under 
which  the  new  equipment  may  even  make  a  slifiicient 
additional  profit  to  take  care  of  the  payments  as  they  be- 
come due.  By  the  judicious  use  of  credit  in  making  pur- 
chases, a  business  of  limited  capital,  in  short,  is  able  to 
maintain  its  "balance,"  or  co-ordination  of  activfties,  so 
that  the  greatest  aggregate  profit  will  be  realized,  and  so 
that  the  growth  or  development  of  the  business  may  take 
place  along  the  lines  of  its  most  profitable  policies.     Such 


PURCHASING  39.3 

considerations  as  these  may  far  outweigh  the  factor  of 
price. 

The  "competitive  system"  in  purchasing. — Under 
the  so-called  competitive  system  of  purchasing  the  speci- 
fications are  drawn  up  to  include  all  the  elements  except 
price.  Bids  or  informal  tenders  are  asked  for — all  likely 
vendors  being  notified  by  advertisement  or  otherwise — 
and  the  contract  is  awarded  after  a  careful  consideration 
of  the  bids  or  informal  tenders  received. 

Emergency  service. — The  buyer,  other  things  being 
equal,  should  place  his  regular  orders  with  the  vendors 
who  are  in  the  best  position  to  render  immediate  service 
in  case  of  emergency.  Emergencies,  in  this  sense,  may 
be  taken  to  include  any  unforeseen  demand  by  the  pur- 
chaser for  the  goods  in  question,  including  demands  for 
repairs  in  case  of  a  breakdown,  or  replacements  in  case 
of  fire  or  other  disaster,  or  demands  for  materials  to  fill 
rush  orders. 

Rush  orders. — Rush  orders  are  frequently  unavoid- 
able, but  are  likely  to  be  expensive  to  buyer  as  well  as 
to  seller,  and  should  be  discouraged,  as  far  as  is  possible. 
Mr.  Elmer  E.  Erickson,  purchasing  agent  of  the  Chicago 
Junction  Railway,  suggests  that  all  rush  orders  be  made 
out  on  special  requisition  blanks  with  a  column  provided 
for  notations  of  extra  costs.  "The  result,"  says  Mr. 
Erickson.  "would  undoubtedly  be  a  more  careful  atten- 
tion to  planning  ahead,  and  a  suppression  of  the  chronic 
rush  order  man."  ^ 

Purchase  orders. — When  the  purchasing  agent  has 
made  his  decision  as  to  the  vendor  from  whom  he  will 

'  100  per  cent.,  April,  1916. 


394 


PRINCIPLES  OF  BUSINESS 


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PURCHASING  395 

purchase  the  goods  in  question,  he  fills  out  an  order  for 
the  goods  and  sends  it  to  the  vendor.  This  order  is 
known  as  the  purchase  order,  and  should  be  made  out  on 
a  standard  form.     A  specimen  form  is  shown  herewith. 

The  original  copy  of  the  purchase  order  is  sent  to  the 
vendor;  the  duplicate  is  filed  in  the  purchasing  depart- 
ment in  the  file  of  "unfilled  orders."  A  third  copy  may 
be  sent  to  the  department  which  has  requisitioned  the 
goods  and  a  fourth  copy  to  the  receiving  department  for 
the  information  of  the  receiving  clerk  in  order  that  he 
may  make  proper  disposition  of  the  goods  upon  their 
arrival.  In  order  to  obtain  an  additional  check  upon  the 
items  of  the  shipment,  the  copy  sent  to  the  receiving  de- 
partment may  not  show  the  quantity  ordered — the  receiv- 
ing clerk,  therefore,  is  forced  actually  to  count  or  weigh 
the  goods.  The  count  of  the  receiving  clerk  should,  of 
course,  tally  with  the  quantity  shown  on  the  original 
order. 

Saving  steps  in  purchasing. — The  two  charts  which 
are  shown  on  the  following  pages  are  designed  to  illus- 
tiate  the  loss  which  results  from  "red  tape"  in  purchasing 
methods. 

Securing  delivery. — When  a  copy  of  the  purchase 
order  is  placed  in  the  "tickler  file"  of  the  purchasing  de- 
partment, a  signal  is  attached  to  it  indicating  the  date 
upon  which  the  goods  should  arrive.  If  the  shipment  is 
not  received  within  the  time  specified  the  purchasing  de- 
partment sends  a  "follow-up"  to  hasten  the  delivery. 
All  goods  must  be  "followed  up"  until  they  are  received. 
The  vendor  is  requested  to  acknowledge  receipt  of  the 
order,  making  at  the  same  time  a  promise  of  delivery. 


396 


PRINCIPLES  OF  BUSINESS 


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PURCHASING 


PROPOSED    PROCEDURE    INCIDENT    TO    PURCHASES    OR    CONTRACTS,    $100    OR 
MORE,    BY   THE    CITY   OF    PHILADELPHIA 


398  PRINCIPLES  OF  BUSINESS 

It  is  often  advisable  to  keep  local  and  out-of-town  pur- 
chase orders  and  correspondence  separate,  in  order  to 
facilitate  the  following  up  of  orders  by  telephone  or  per- 
sonal calls,  in  the  case  of  orders  placed  with  local  vendors. 

Receiving  the  goods, — When  the  goods  arrive  at  the 
receiving  room,  the  receiving  clerk  enters  the  quantity 
received  on  a  "material  received  slip."  Records  of  ma- 
terials received  are  made  in  duplicate,  one  copy  going  to 
the  general  office,  where  it  is  checked  up  with  the  seller's 
invoice  before  the  bill  is  paid;  the  other  copy  goes  with 
the  goods  themselves  to  the  store  room,  where  the  per- 
petual-inventory clerk  compares  the  quantity  with  that 
appearing  on  the  material-received  sheet  before  making 
entries  on  his  stock  cards. 

Inspection. — When  the  goods  are  received  they  must 
be  inspected.  If  found  to  conform  to  the  specifications 
of  the  purchase  contract,  they  will  be  accepted  and  put 
into  stores  or  sent  to  the  "jobs"  where  they  are  to  be 
used.  If  defective,  they  will  be  returned  to  the  vendor 
or  held  pending  an  adjustment. 

With  respect  to  some  classes  of  goods  a  simple  exam- 
ination of  the  articles  received  is  sufficient,  but  with  re- 
spect to  other  classes  elaborate  chemical  or  physical  tests 
must  be  applied.  These  tests  are  applied  by  means  of 
the  equipment  in  the  experimental  and  testing  laborato- 
ries mentioned  earlier  in  this  chapter — the  laboratories 
serving  the  double  purpose  of  furnishing  the  data  from 
which  the  standard  or  special  specifications  may  be 
evolved,  and  afterward  of  testing  the  goods  or  materials 
in  question  with  respect  to  their  conformity  to  the  re- 
quirements of  the  specifications.     In  the  case  of  goods 


PURCHASING  399 

which  require  chemical  or  physical  testing  in  the  process 
of  inspection,  the  incoming  shipment  will  be  routed 
through  the  receiving  department  via  the  engineering  de- 
partment. 

Inspection  at  the  source. — The  responsibility  and 
reputation  of  the  vendor  determine,  as  a  rule,  the  degree 
of  rigidity  with  which  inspection  must  be  made  before 
the  goods  are  accepted.  Even  in  the  best  of  faith,  how- 
ever, the  vendor  may  be  turning  out  parts  or  other  sup- 
plies which  upon  delivery  would  be  found  to  be  defective 
— perhaps  because  of  a  misinterpretation  of  the  specifica- 
tions covering  them.  Inspection  at  the  source,  therefore, 
is  sometimes  resorted  to,  the  purchasing  company,  with 
the  consent  of  the  vendor,  placing  an  inspector  in  the 
vendor's  plant  to  make  certain  that  no  mistakes  are  made 
in  their  manufacture.  By  inspection  at  the  source  delays 
are  avoided  and  the  waste  of  material  is  prevented. 

Return  of  defective  goods. — Goods  inspected  and 
found  defective  v;ill  be  refused  and  either  returned  to  the 
seller  or  held  at  his  disposal,  unless  an  adjustment  in  price 
or  otherwise  can  be  agreed  upon.  Here  again  it  is  im- 
portant to  note  that  the  purchasing  agent  should  have  a 
knowledge  of  his  legal  rights  in  rejecting  shipments 
found  defective.  With  respect  to  all  sets  of  specifica- 
tions the  "limits  of  tolerance"  should  be  defined. 

Keeping  stock  records. — Accurate  stock  records,  as 
suggested  by  W.  R.  Basset  in  the  American  Machinist, 
May  6,  1920,  are  just  as  important  as  accurate  money 
records.  The  purposes  of  the  stock  record,  as  summed  up 
by  Mr.  Basset,  are  :  (i)  to  make  sure  that  all  materials 
are  used  for  proper  purposes;  (2)  to  prevent  production 


400  PRINCIPLES  OF  BUSINESS 

delays  through  lack  of  needed  material;  (3)  to  prevent 
o\'erbnying-  and  misuse  of  capital;  (4)  to  make  sure  that 
all  material  will  be  accounted  for  as  part  of  the  finished 
cost;  (5)  to  facilitate  inventories;  (6)  to  save  the  time 
of  workmen  ready  and  calling  for  supplies. 


BIBLIOGRAPHY 

Field,  Clifton  C,  Retail  Buying. 

Hochkia,  W.  R.,  Makiruj  More  Money  in  Store^Keeping. 

Rindfoos,  C.  S.,  Purchasing. 

Twyford,  H.  B.,  Pxir chasing. 

Nelson,  VV.   P.,   Purchasing   By  Specificaiions. 

Kimball,  D.  S.,  Principles  of  Industrial  Organization, 


CHAPTER   XVIII 

SELLING 

THE   POINT  OF  VIEW 

What  is  a  need — how  ascertained? — "If  you  need  a 
thing  you  pay  for  it  whether  you  buy  it  or  not."  So  runs 
the  argument  of  the  salesman,  and  his  saying  is  a  true 
one.  We  may  pay  for  it  in  money,  or  in  heahh,  or  in 
happiness.  If  we  need  it  and  do  not  buy  it,  it  costs  us 
more.  The  salesman  is  justified,  therefore,  in  using 
every  effort  to  sell  us  what  we  need. 

But  how  does  the  salesman  know  whether  we  need  a 
thing  or  not?  How  do  we  know,  ourselves?  What  is  a 
need,  and  how  does  it  differ  from  a  mere  "want"  ?  We 
may  want  an  expensive  automobile,  but  if  we  cannot 
afford  it,  we  do  not  need  it.  We  may  not  need  it,  even 
if  we  can  afford  it.  Most  needs  are  not  absolute,  but 
comparative.  We  may  need  something  else  more.  We 
should  always  want  more  than  we  need,  but  our  wants 
should  develop  into  needs  only  after  our  earlier  or  more 
important  needs  have  been  satisfied,  and  then  only  in 
proper  perspective.  For  example,  we  may  want  an  auto- 
mobile— even  need  one  as  providing  healthful  diversions 
from  hard  work — but  this  want  should  not  be  magnified 
into  a  need  for  a  Rolls-Royce  or  a  Pierce  Arrow,  unless 
there  is  no  question  as  to  our  being  able  to  afford  it. 

Again,  we  may  need  a  thing  and  still  not  want  it.     We 

401 


402  PRINCIPLES  OF  BUSINESS 

may  not  know  we  need  it,  or  it  may  be  something  dis- 
agreeable, which  we  put  off  getting  for  as  long  a  time  as 
possible.  Who  is  to  decide  whether  we  need  it  or  want  it 
— we  ourselves,  or  the  salesman? 

We  may  sometimes  thank  the  salesman  for  having  sold 
us  something  which  at  the  time  we  did  not  want  and  did 
not  know  we  needed — insurance,  for  example ;  or  we  may 
harbor  a  lasting  resentment  toward  him  because  he  has 
induced  us  to  purchase  something  which  we  did  not  need 
— somebody's  autobiography  in  seven  volumes,  for  ex- 
ample. We  will  not  buy  anything  else  from  him,  no  mat- 
ter how  badly  we  need  it. 

Consumers'  needs  the  basis  of  profitable  selling. — 
The  purpose  of  these  rather  trite  observations  is  to  bring 
out  the  fact  that,  in  selling,  there  must  be  established  a 
certain  point  of  view.  What  shall  be  our  motives  in  sell- 
ing, what  circumstances  shall  determine  whether  or  not 
we  should  endeavor  to  make  a  sale?  We  desire,  of 
course,  to  make  as  much  profit  as  we  can — not  upon  a 
single  sale  but  upon  the  aggregate  of  our  sales.  How 
may  this  result  be  secured?  Obviously,  only  by  satisfy- 
ing the  real  needs  and  real  wants  of  the  consumer.  Any 
selling  which  is  not  based  ultimately  upon  the  consumer's 
needs  and  wants  must  shortly  prove  to  have  been  un- 
profitable. When  the  producer  sells  to  the  dealer,  for  ex- 
ample, it  is  not  enough  that  the  dealer  shall  have  thought 
that  he  needed  the  goods.  The  dealer  may  have  over- 
estimated the  demand,  or  may  not  have  understood 
thoroughly  the  nature  or  quality  of  the  goods.  The  only 
safe  basis  is  the  actual  need  of  the  consumer,  and  the 
producer  cannot  escape  the  responsibility  which  rests  pri- 


SELLING  403 

marily  upon  him  to  determine  this  need — for  he  knows, 
or  should  know,  better  than  anyone  else,  the  nature  of  his 
goods  and  their  adequacy  or  inadequacy  to  supply  the 
consumer's  needs. 

Motives,  however  sincere,  are  poor  guides  unless  en- 
lightened by  knowledge.  When  the  blind  lead  the  blind, 
both  fall  into  the  ditch.  The  producer  and  the  dealer 
must  unite  their  efforts  to  ascertain  ( i )  the  needs  of  the 
consumer,  through  analysis  of  the  market,  and  (2)  the 
suitability  of  the  goods,  through  analysis  of  the  goods 
themselves,  in  their  relation  to  market  needs.  Market 
must  be  regarded  as  being  the  demand  of  consumers,  and 
not  that  of  dealers. 

The  consumer  pays. — We  should  not  begrudge  the 
consumer's  enjoyment  of  the  special  consideration  which 
he  receives.  He  pays  for  it.  In  the  appropriate  words 
of  Paul  E.  Derrick,  creator  of  the  "Gold  Dust  Twins," 
"Johnny  Walker,"  the  "Quaker  Oats"  man,  and  other 
notable  personages  in  the  world  of  advertising:  "The 
consumer  pays  for  the  oil  used  in  the  engine,  the  ink  used 
in  printing  the  invoice,  the  bookkeeper's  pen,  the  chair- 
man's mahogany  desk,  the  cost  of  cutting  the  grass  in 
front  of  the  office,  the  director's  motor  car,  the  page's 
buttons,  the  firm's  subscriptions  to  charity,  the  very  smoke 
that  floats  from  the  tall  chimney;  and,  finally,  the  simple 
or  elaborate  tomb  to  mark  the  last  resting  place  of  the 
body  of  the  man  who  possessed  the  requisite  genius  to 
make  the  dream  a  reality."  ^ 

The  function  of  selling,  defined.— Selling,  in  its  true 

1  Paul  E.  Derrick,  How  to  Reduce  Selling  Costs,  George  Newnes, 
Ltd.,  London,  1916. 


404  PRINCIPLES  OF  BUSINESS 

function,  accordingly,  is  seen  to  be  the  exchanging"  of 
goods  for  money  or  its  equivalent,  resulting  in  the  satisfy- 
ing of  a  need  of  the  consumer,  the  gratification  of  which 
is  within  his  financial  means.  Selling  upon  any  other 
basis  brings  a  train  of  economic  losses  in  its  wake,  which 
adjust  themselves  finally  as  losses  to  all  concerned  in  the 
transaction.  The  function  of  selling  is  primarily  the  dis- 
tribution of  the  world's  goods  to  the  places  where  and 
at  the  times  when  they  are  needed;  and  the  profit  to  the 
sellers  tends  to  be  in  proportion  to  the  service  which  they 
render  in  making  this  distribution.  Thus  the  rendering 
of  the  greatest  service  becomes  the  means  of  making  the 
greatest  profit. 

THE  COSTS  OF  SELLING 

Thte  high  cost  of  selHng. — It  costs  more  to  sell  the 
world's  goods  than  to  make  them.  That  this  is  true  is 
generally  known,  but  cannot  be  generally  realized,  or 
there  would  surely  be  a  greater  effort  made  to  reduce  the 
costs  of  selling.  The  amounts  involved  are  so  large  that 
even  a  slight  improvement  in  technique  might  effect  a 
saving  of  billions  of  dollars  a  year.  Perhaps  an  explana- 
tion of  the  apathy  of  the  public  with  respect  to  this  prob- 
lem is  in  the  fact  that  the  increase  in  the  cost  of  selling 
has  been  a  gradual  one,  coming  so  slowly  as  to  take  the 
world  unawares. 

In  the  earlier  periods  of  industrial  history,  when  needs 
were  fewer  and  simpler,  production  was  the  main  prob- 
lem. Production  was,  for  the  most  part,  localized — that 
is,  each  community  was  self-sustaining.  The  producer 
must  have  been  able  to  gauge  to  a  nicety  the  demands 


SELLING  405 

of  his  market,  and  to  adjust  his  output  accordingly.  The 
consumers  must  have  been  able  to  convey  to  the  producer 
exact  information  as  to  their  needs.  We  know,  as  a 
matter  of  fact,  that  nearly  all  goods  were  "custom  made," 
that  is,  made  to  order. 

Crude  as  were  the  methods  in  those  days,  there  must 
have  been  but  little  misdirection  of  effort,  so  far  as  sell- 
ing was  concerned,  except  that  an  indefinite  amount  of 
time  may  have  been  spent  in  bargaining.  Production 
costs  were  high,  of  course,  because  labor-saving  methods 
had  not  been  devised ;  machinery  was  uninvented ;  time- 
and-motion  study  had  not  been  thought  of;  but  selling 
costs  were  low. 

With  such  an  assumed  condition  as  our  starting-point, 
let  us  consider  how  and  why  the  change  has  come  about ; 
for  now  production  costs  are  low  and  selling  costs  are 
high. 

Elements  of  the  selling  cost. — The  selling  cost  is 
made  up  of  all  the  costs,  with  the  exception  of  the  pro- 
ducer's profit,  attaching  to  a  product  after  it  reaches  its 
consumable  form,  and  is  the  difference  between  the  sell- 
ing price  and  the  sum  of  the  production  cost  and  the  pro- 
ducer's profit.  It  might  seem  that  dealers'  profits  were  not 
a  cost,  in  the  same  sense  in  which  their  actual  expenses 
are  a  cost,  but  this  objection  tends  to  disappear  when  we 
consider  that  the  profit  of  the  dealer  is  the  amount  paid 
to  him  in  order  that  he  may  be  willing  to  perform  his 
function  of  distribution.  If  this  is  true,  his  profit  is  a 
selling  cost  as  truly  as  the  wages  of  the  delivery  boy  is 
a  selling  cost. 

A  grouping  of  the  various  items  of  selling  cost  such  as 


4o6  PRINCIPLES  OF  BUSINESS 

follows  cannot,  of  course,  represent  the  actual  distribution 
of  costs  in  particular  cases,  but  it  may  serve  to  give  us  a 
clearer  visualization  of  some  of  the  problems  in  the  re- 
duction of  selling  costs,  aside  from  those  involved  in  the 
organization  of  business  as  a  whole,  touched  upon  above. 
The  function  of  selling,  like  other  functions  of  a  business, 
may  be  subdivided  into  planning  and  performing. 

SELLING  COSTS  ENTERING  INTO  THE  SELLING  PRICE 

1.  Planning 

a.  Market    analyses;    theoretical    correlation    of 

market  and  product 

b.  Advertising;  purchase  of  good-will 

c.  Credit  investigations 

2.  Perforfiiing  (execution  of  plans) 

a.  Investment  in  buildings  and  equipment  devoted 

to  selhng;  up-keep;  fixed  charges 

b.  Salaries,    wages    and    expenses    of    managers, 

salesmen ;  and  other  employees 

c.  Distribution 

(i)   Transportation     of     product    to     sales 
depots;  rehandling 

(2)  Storage,  insurance,  depreciation 

(3)  Delivery  to  consumer 

d.  Collections  and  bad  debt  losses 

3.  Profits 

Why  selling  costs  are  high.— Why  should  these  costs 
of  selling  have  come  to  be  a  greater  factor  in  the  selling 
price  than  the  costs  of  producing?  The  explanation  of 
this  condition  is  in  the  fact,  on  the  one  hand,  that  more 
attention  has  been  directed  toward  lowering  the  costs  of 


SELLING  407 

production;  and  on  the  other  hand,  in  that  the  factors 
entering  into  the  selhng  cost  are  more  difficult  to  estimate 
and  control  than  are  the  elements  entering  into  the  costs 
of  production.  It  would  seem  that  modern  business  has 
attacked  its  problems,  so  to  speak,  at  the  wrong  end.  The 
manufacturer  has  built  his  plant,  produced  his  goods  and 
then  has  expected  the  selling  department  to  dispose  of 
them.  The  competition  between  producers,  who  have 
been  turning  out  goods  in  the  greatest  quantities  possible, 
without  due  regard  to  the  actual  demand,  has  caused  ex- 
cessive advertising  and  salesmanship  costs,  as  well  as  ex- 
cessive costs  of  distribution,  the  latter  resulting  from 
duplication  of  delivery  systems  serving  the  same  con- 
sumers. Since  competition  tends  continually  to  force 
down  the  selling  price,  the  manufacturer  has  endeavored 
to  meet  this  competition  by  reducing  the  costs  of  produc- 
tion, which  he  finds  himself  best  able  to  do  by  increasing 
his  output — by  taking  advantage  of  the  economies  of 
large-scale  production,  thus  overcoming  the  outstanding 
defect  of  the  earlier  regime,  in  which  the  cost  of  produc- 
tion was  high.  Production,  accordingly,  has  been  pro- 
portioned to  the  best  efforts  of  the  selling  department 
rather  than  to  the  actual  needs  of  the  public.  Planning 
for  sales  has  followed  production,  instead  of  preceding 
and  determining  production. 

The  inevitable  consequence  of  such  a  maladjustment  of 
effort  has  been  the  present  high  cost  of  selling — high,  be- 
cause every  stage  of  the  selling  process  is  attended  by 
uncertainties.  We  may  readily  see  how  the  entering  of 
uncertainty  into  each  of  the  various  phases  of  the  selling 
operation  has  caused  an   increase  in  cost,   if  we  trace 


4o8  PRINCIPLES  OF  BUSINESS 

briefly  the  evolution  of  selling  methods  from  the  early 
days,  when  selling  costs  were  of  minor  importance,  until 
the  present,  when  they  are  larger  than  production  costs. 
We  may  assume,  in  the  first  place,  that  with  the  widening 
of  the  market  the  producer  found  himself  unable  any 
longer  to  keep  in  touch  with  his  customers.  His  cus- 
tomers no  longer  came  into  his  place  of  business,  explain- 
ing exactly  what  they  needed.  Instead  of  making  or 
producing  for  a  known  and  definite  demand,  the  producer 
was  obliged  to  guess  at  what  was  required.  If  he  pro- 
duced too  much,  he  lost.  If  he  produced  the  wrong 
article,  he  lost.  To  offset  the  cost  of  this  uncertainty, 
accordingly,  he  was  compelled  to  add  a  considerable  per- 
centage to  his  selling  price. 

Again,  taking  only  the  most  obvious  phases  of  the  un- 
certainty which  it  has  become  necessary  to  provide 
against,  there  ar®se  the  uncertainty  of  payment.  Not 
knowing  his  customers  personally,  the  producer  could  no 
longer  be  sure  of  collecting  his  money  when  he  made  a 
sale.  Each  bad  debt  offset  the  profits  on  a  number  of 
sales. 

With  the  greater  distances  goods  had  to  be  moved,  de- 
livery became  uncertain.  Shipments  might  go  astray; 
perishable  products  might  spoil  in  transit;  goods  over- 
due might  be  rejected.  Clearly,  it  became  necessary  to 
adjust  the  selling  price  to  offset  the  cost  of  this  uncer- 
tainty. 

Competition  itself  became  uncertain.  The  producer 
could  not  know  who  and  how  many  his  competitors  were, 
what  their  methods  were,  what  their  prices  would  be. 
He  might  find  himself  alone  upon  the  market,  or  he  might 


SELLING  409 

find  the  market  overstocked,  so  that  none  could  make 
a  profit.  Such  a  competition  in  the  dark,  with  its  dupli- 
cation of  effort  and  non-adjustment  of  supply  to  demand, 
could  not  but  add  an  appreciable  amount  to  the  selling 
cost. 

The  elimination  o£  uncertainty. — These  observa- 
tions, made  almost  at  random  in  view  of  the  conditions 
which  modern  selling  labors  under,  would  seem  to  justify 
us  in  the  conclusion  that  the  most  pressing  need  of  busi- 
ness, in  order  that  the  cost  of  selling  may  be  reduced,  is 
the  elimination,  so  far  as  possible,  of  uncertainty.  Among 
the  obvious  means  of  doing  away  with  uncertainty  are : 
(i)  accumulation  and  classification  of  information,^  (2) 
progressive  standardization,  and  (3)  a  functional  divi- 
sion of  the  labor  of  manufacturing  and  distributing. 
Business,  of  course,  has  recognized  the  value  of  stand- 
ardization and  of  a  functional  division  of  manufacturing 
and  selling,  and  has  made  some  progress  with  these  ends 
in  view,  but  the  progress  has  been  limited  because 
business  has  not  been  organized  under  a  controlling 
centralized  authority.  The  public  has  been  unwill- 
ing to  permit  such  combinations  of  businesses  as  would 
have  made  possible  an  interbusiness  standardization 
and  functional  division  of  labor,  particularly  with 
respect  to  sales  and  distribution,  fearing  that  busi- 
ness would  not  use  its  power  wisely  and  in  the 
public  interest.  With  the  growing  recognition  of  the 
fact,  however,  that  in  the  long  run  the  interests  of  busi- 
ness and  the  interests  of  the  public  are  nearly,  if  not  quite, 
identical,  it  is  probable  that  in  the  future  such  a  combina- 

1  Attention  is  called  to  the  work  of  Trade  Organizations. 


4IO  PRINCIPLES  OF  BUSINESS 

tion  or  federation  will  be  permitted;  although  it  is  doubt- 
ful as  yet  how  much  governmental  control  will  be  main- 
tained after  the  present  war  emergency  conditions  are 
past.  It  seems  safe  to  say  that  business  must  either 
prove  itself  worthy  of  being  granted  self-government,  or 
must  submit  to  a  large  measure  of  control  by  the  political 
government.  In  any  case,  business  must  have  a  head. 
Standardization,  with  its  implied  correlation  and  co- 
ordination, can  be  effected  only  by  the  management,  and 
not  by  the  units  composing  the  organization. 

Objectives  of  the  seller. — Contrary,  perhaps,  to  popu- 
lar suppos-ition,  the  enlightened  seller,  except  in  isolated 
transactions,  does  not  endeavor  to  sell  his  goods  at  the 
highest  prices  possible,  but  at  the  lowest  prices  possible, 
consistent  with  a  safe  margin  of  profit.^  He  depends, 
for  his  aggregate  profit,  upon  a  high  rate  of  turnover  and 
a  large  volume  of  business,  knowing  that  high  prices  will 
only  attract  competition,  or  drive  away  his  customers, 
and  make  it  more  difficult  for  him  subsequently  even  to 
make  any  profit  at  all.  Good-will  is  an  asset  that  must 
be  preserved  at  all  costs.  Thus  the  seller,  whether  natu- 
rally so  inclined  or  not,  is  compelled  to  be  quite  ethical  in 
his  dealings  with  the  public.  He  knows  that  if  he  takes 
care  of  service,  profits  will  take  care  of  themselves  or, 
at  any  rate,  that  they  will  require  a  minimum  of  attention. 
He  knows  that,  as  the  preacher  said,  "Honest}-  is  the  best 
policy — in  the  long  run." 

1  Care  must  be  taken  to  differentiate  between  selling  jirice  and 
selling  cost.  Selling  price  includes  all  costs  and  profits,  including 
those  of  the  producer.  Selling  cost  includes  all  costs  and  profits 
exclusive  of  those  of  the  producer.  The  seller,  of  course,  is  inter- 
ested in  keeping  down  the  price  by  keeping  down  all  costs  except 
his  own  profits. 


SELLING  411 

Selling,  then,  like  other  functions  of  a  business,  de- 
mands the  ascertainment  of  the  "one  best  way" — the  way 
of  the  least  economic  waste.  Our  consideration  of  the 
means  of  eliminating  economic  loss  in  selling  or,  in  other 
words,  of  lowering  the  costs  of  selling  leads  us  to  divide 
the  subject  into  three  main  parts,  in  the  pages  that  follow. 
These  three  divisions  of  the  problem  will  be  entitled : 
"Correlation  of  Market  and  Product;"  "Salesmanship;" 
and  "Distribution."  Other  phases  of  the  selling  problem, 
including  "Advertising,"  "Credit"  and  "Traffic,"  are  con- 
sidered in  separate  chapters. 

CORRELATION   OF   MARKET  AND   PRODUCT 

Knowledge  of  the  product  itself. — The  first  step  in 
selling,  or  at  any  rate  in  salesmanship,  with  respect  to  the 
selling  of  any  given  product,  is  the  acquiring  of  a 
thorough  knowledge  of  the  product  itself  and  its  suit- 
ability or  adaptability  to  market  needs. 

Demand. — The  question  must  be  considered,  is  the 
article  in  demand?  Is  the  demand  actual,  or  is  it  merely 
potential — that  is,  developed,  or  undeveloped?  If  the 
demand  has  been  developed,  has  it  been  through  educa- 
tion of  the  public  to  the  recognition  of  the  value  of  such 
an  article  or  is  the  article  a  necessity,  which  to  be  sold, 
needs  but  to  be  seen  ? 

Developed  demand. — If  the  demand  has  been  devel- 
oped as  a  result  of  educational  propaganda  in  the  past,  a 
study  of  the  methods  which  have  proved  most  successful 
is  likely  to  be  of  value  in  determining  the  methods  of 
exploitation  which  are  to  be  adopted. 

Undeveloped  demand. — If,  however,  the  demand  is 
latent,  a  consideration  of  the  educational  methods  which 


412  PRINCIPLES  OF  BUSINESS 

have  proved  successful  in  similar  cases  may  be  profitable. 
There  must,  of  course,  be  a  careful  investigation,  in  the 
latter  case,  of  the  reasons  why  the  demand  has  not  been 
developed.  It  may  be  that  there  is  some  feature  of  the 
article  or  of  such  an  article,  that  has  disagreeable  associa- 
tions; or  it  may  be  that  the  public  has  become  prejudiced 
against  articles  of  this  class  for  some  ascertainable  and 
removable  cause. ^  If  there  appears  no  intrinsic  reason 
why  the  article  should  not  come  into  general  use,  the 
study  will  next  take  the  form  of  determining  how  a  de- 
mand may  most  easily  or  most  economically  be  developed. 
Forced,  or  natural,  demand? — A  further  considera- 
tion, closely  allied  to  the  foregoing,  is  whether  the  de- 
mand— if  it  exists — is  forced,  or  natural.  An  artificial 
demand  may  be  created — that  is,  the  public  may  be  in- 
duced to  want  something  which  it  does  not  need.  Aside 
from  the  question  of  ethics  involved  in  forcing  the  sale 
of  an  article  of  doubtful  value,  such  a  demand  is  likely 
to  be  maintained  only  at  considerable  advertising  cost, 
and  is  likely  to  vanish  at  any  time  in  spite  of  all.  If,  on 
the  other  hand,  the  demand  is  a  natural  one — that  is,  if 
the  article  meets  a  fundamental  human  need,  the  cost  of 
maintaining  publicity,  once  the  article  becomes  known,  is 
negligible  by  comparison. 

^  Choosing  an  illustration  at  random,  there  are  many  uses  for 
dynamite  in  farming  and  amateur  engineering.  It  is  difficult, 
however,  to  popularize  its  use,  because  the  public  formed  its 
opinion  of  djtiamite  in  the  earlier  days,  before  improved  methods 
of  manufacture  and  control  had  removed  the  element  of  uncer- 
tainty as  to  when  and  under  what  conditions  it  would  explode. 
The  Du  Pont  Powder  Company  has  spent  a  considerable  amount 
of  money  in  advertising  and  in  making  practical  demonstrations  in 
agricultural  communities  of  the  employment  of  dynamite  for 
clearing  land  of  stumps  and  boulders,  pulverizing  the  soil  before 
planting  fruit  trees,  and  the  like. 


SELLING  413 

Continuity  of  demand. — The  demand  will  also  be  con- 
sidered, as  to  whether  it  is  permanent,  temporary,  or  sea- 
sonal. It  will  be  remembered  that  an  article  which  meets 
a  seemiingly  permanent  demand  may  at  any  time  be  dis- 
placed by  the  introduction  of  a  cheaper  or  a  superior 
article  which  meets  the  same  need.  If  the  demand  is 
temporary,  it  must  be  determined  whether  enough  sales 
can  be  made  within  the  limited  time  to  justify  the  cost  of 
the  selling  organization.  If  the  demand  is  seasonal,  it 
must  be  remembered  that  the  sales  organization  will  have 
to  be  maintained,  even  although  at  a  lessened  expense, 
during  the  time  of  the  year  when  no  sales  can  be  made. 
The  cumulative  value  of  advertising  is  also  lost  to  a  large 
extent  when  publicity  is  discontinued  for  a  time.  Numer- 
ous other  considerations  similar  to  these  will  suggest 
themselves. 

Serviceability. — The  considerations  touched  upon 
above  relate  to  the  existence  or  non-existence  of  a. de- 
mand. The  question  of  serviceability,  while  not  entirely 
dissimilar,  relates  to  the  use  which  purchasers  will  make 
of  the  article. 

Necessity,  or  luxury. — In  the  first  place,  with  a  view 
to  determining  the  sales  arguments  to  be  used,  the  sug- 
gestions which  will  prove  most  effective,  as  well  as  the 
classes  of  buyers  who  will  be  appealed  to,  the  article  or 
product  must  be  classified,  as  to  whether  it  is  a  "neces- 
sary," a  "necessity,"  a  "convenience"  or  a  "luxury."  The 
distinction  between  a  "necessary"  and  a  "necessity"  may 
be  pointed  out.  A  "necessary"  is  something  like  food  or 
clothing,  which  is  indispensable  in  the  support  of  life, 
while  a  "necessity"  is  vital  only  for  certain  objects. 


414  PRINCIPLES  OF  BUSINESS 

General  or  special  service. — The  selling  plans  will  be 
made  in  view  also  of  whether  the  article  will  be  of 
general  service,  or  of  only  a  special  or  limited  service. 
If  the  article  is  a  soap,  for  example,  it  may  be  taken  for 
granted  that  if  it  is  a  toilet  or  a  laundry  soap  the  sales 
appeal  will  be  a  general  one,  based  on  some  special  superi- 
ority or  attractiveness  of  the  product.  If,  however,  it  is 
a  "healing"  soap,  or  a  dog  soap,  the  appeal  will  be  of  a 
special  kind,  addressed  to  special  audiences. 

Variety  of  uses. — A  consideration  somewhat  similar 
to  that  noted  above  is  whether  the  article  has  but  one 
use,  or  various  uses.  The  more  uses  it  has,  the  more 
"talking-points"  can  be  thought  of.  This  feature  forms 
the  basis  of  one  of  the  well-known  Sapolio  advertisements 
— "There  are  many  uses  for  Sapolio — everyone  finds  a 
new  use."  We  are  familiar  also  with  advertisements  of 
gasoline  engines,  which  are  shown  at  their  household 
tasks — pumping  water,  washing  clothes,  churning,  or  gen- 
erating electricity  for  lights.  Each  additional  use  which 
may  be  made  of  an  article  makes  it  easier  to  sell. 

Durability. — The  question  of  durability  involves  not 
only  the  satisfaction  which  the  article  will  give  to  the 
purchaser,  but  also  the  length  of  time  the  article  may  be 
expected  to  last — whether  it  will  last  indefinitely  or  be 
replaced  from  time  to  time.  It  will  readily  be  seen  how 
different  in  these  respective  cases  will  be  the  selling  plan 
and  the  sales  organization.  In  either  case,  there  must  be 
a  post-sale  service,  but  if  the  article  is  one  which  is  a  fix- 
ture the  service  will  take  the  form  of  interest  in  the  cus- 
tomer's satisfaction,  and  readiness  to  supply  repairs; 
whereas  if  the  article  is  short-lived  there  will  be  a  constant 


SELLING  415 

succession  of  additional  sales-appeals,  probably  with 
stress  upon  the  user's  previous  satisfaction  and  upon  the 
willingness  of  the  seller  to  guarantee  future  satisfaction. 

Basis  of  appeal. — The  product  will  be  studied  further 
with  regard  to  the  kind  of  want  which  it  will  satisfy — 
as  to  whether  its  use  is  economical;  or  whether  it  must 
make  an  appeal  rather  to  comfort,  or  to  pride. 

If  the  use  of  the  article  or  product  involves  extra  ex- 
pense, it  may  be  possible  to  show  that,  nevertheless,  a  sav- 
ing is  effected.  A  vacuum  cleaner,  for  example,  costs 
more  than  a  broom,  but  less  than  a  doctor  and  a  trained 
nurse.  Dust  is  not  only  dangerous,  but  expensive.  It 
spoils  the  furniture  and  soils  the  clothes.  It  may  be 
shown  that  it  might  pay  to  get  a  vacuum  cleaner  and 
charge  the  extra  expense  against  the  saving  in  laundry 
bills,  and  the  saving  in  time.  Perhaps  with  the  help  of 
a  vacuum  cleaner  one  maid  might  do  the  work  of  two. 

It  may  be  advisable,  or  even  unavoidable,  to  disregard 
the  question  of  economy,  and  to  decide  upon  making  an 
appeal  to  pride  or  to  some  other  instinct.  A  careful  study 
of  the  product  is  necessary  before  it  can  be  known  which 
course  is  best. 

Quality. — The  preliminary  study  of  the  product  must 
include  also  finding  out  what  its  "quality"  is.  Quality 
is  a  composite  of  materials,  design,  workmanship,  appear- 
ance and  finish.  The  quality  will  affect  in  several  ways 
the  nature  of  the  sales-appeal  and  the  selection  of  the  class 
of  buyers  to  whom  the  sales-appeal  will  be  directed. 

While  there  must,  of  course,  be  a  proper  balance  of 
the  various  elements  which  enter  into  quality,  we  may 
assume   that   the   production   department  has   fixed   the 


4i6  PRINCIPLES  OF  BUSINESS 

grades  of  material  and  workmanship,  and  that  it  is  now 
the  task  of  the  sales  department  to  evolve  the  most  effec- 
tive means  of  presenting  the  merits  of  the  article  to  the 
public.  The  sales  appeal  must  be  specific,  if  it  is  to  be 
effective ;  it  may  be  taken  for  granted  that  generalities  are 
uninteresting.  The  most  interesting  or  the  most  desir- 
able quality  which  the  article  possesses  is  likely  to  be  fea- 
tured in  the  advertising  and  in  the  arguments  used  by 
the  salesman. 

The  advertiser  should  know  the  product  thoroughly, 
in  order  to  present  its  merits  not  only  forcefully  but  in- 
telligently. For  the  same  reason,  the  salesman  must 
know  as  much  as  he  can  learn  about  the  article  he  is 
selling,  because  he  represents  the  house  and  the  article, 
and  the  buyer  is  likely  to  judge  both  by  the  salesman  him«- 
self. 

If  the  salesman  cannot  give  intelligent  answers  to  ques- 
tions about  material  and  workmanship  the  buyer  imme- 
diately loses  confidence  in  him,  and  at  the  same  time  loses 
confidence  in  the  product  and  in  the  house  that  was  so 
inefficient  as  to  send  out  an  ignorant  salesman.  He  feels 
that  somebody  is  "trying  to  put  something  over  on  him" 
for  the  sake  of  a  profit  on  the  sale — that  the  house  is  lack- 
ing in  the  sense  of  responsibility  which  a  reputable  house 
feels  toward  its  customers — for  how  could  such  a  sales- 
man be  the  medium  through  which  service  could  be  given  ? 
If  he  does  not  know  his  product,  he  cannot  know  its  uses 
and  the  conditions  under  which  it  will  or  will  not  give 
satisfaction.  In  these  days  the  buyer  has  the  right  to 
expect  and  to  demand  service  with  every  sale. 

Name  or  trade-mark. — A  vital  consideration  in  the 


SELLING  417 

selling  of  almost  any  product  is  that  of  how,  upon  the 
market,  it  may  be  identified  or  distinguished  from  similar 
products.  It  is  obvious  that  in  order  that  a  cumulative 
value  may  be  given  to  sales  appeals  the  product  must  be 
an  entity.  To  be  an  entity  it  must  have  certain  dis- 
tinguishing characteristics,  and  must  have  a  name.  The 
product  may  have  a  name  of  its  own,  or  may  bear  the 
name  or  trade-mark  of  the  house  that  manufactures  or 
sells  it. 

The  name  should,  of  course,  be  free  from  legal  diffi- 
culties. Aside  from  the  ethics  involved  in  unfair  com- 
petition, money  spent  in  promoting  the  sale  of  an  article 
or  in  building  up  a  business  the  name  of  which  is  mis- 
leading is  for  the  most  part  spent  in  advertising  the  orig- 
inal or  genuine.  If  profits  are  made,  in  such  a  case,  they 
are  likely  to  be  spent  in  defending  infringement  suits 
or  in  satisfying  judgments. 

With  respect  to  trade-names,  percentage  of  confusion 
between  them  (determined  by  an  interesting  series  of 
psychological  experiments),  and  the  legal  decisions  in  the 
general  cases,  Paynter^  ekes  the  following  examples : 


Per  Cent 

Legal 

Original 

Imitation 

Confusion 

Decision 

Sozodont 

Kalodont 

28 

Non-infringement 

Nox-all 

Non-X-ell 

28 

Infringement 

Club 

Chancellor  Chib 

35 

Infringement 

Bestyette 

Veribest 

35 

Non-infringement 

Mother's 

Grand-Ma's 

38 

Non-infringement 

Au-to-do 

Autola 

40 

Infringement 

Peptenzyne 

Pinozyne 

43 

Non-infringement 

Green  River 

Green  Ribbon 

50 

Infringement 

Ceresota 

Cressota 

63 

Infringement 

^  Richard  H.  Paynter,  "Psychological  Study  of  Confusion  Between 
Word  Trade-marks,"  Bulletin  of  United  States  Trade-mark  Asso- 
ciation.  May,  1915. 


4i8  PRINCIPLES  OF  BUSINESS 

The  name  chosen  to  identify  the  product  should  not 
only  be  free  from  legal  difficulties  but  should  be  distinc- 
tive. A  suggestive  name  is  usually  preferable  to  a  mean- 
ingless name,  but  a  "coined"  name  without  objectionable 
features  may  be  given  a  meaning  by  means  of  a  consistent 
advertising  policy  and  by  means  of  a  consistent  quality  in 
the  article  itself.  "Kodak,"  for  example,  when  it  was 
first  coined  was  merely  a  combination  of  letters  or  sounds, 
and  meant  absolutely  nothing,  but  now  it  means  a  great 
deal,  and  is  worth  a  great  deal. 

Besides  being  distinctive,  if  not  suggestive,  a  trade- 
name should  be  pleasing  in  sound  and  easy  to  pronounce. 
"Baby-talk"  names,  sometimes  attached  to  food-products, 
are,  to  many  people,  exceedingly  offensive.  People  can- 
not be  induced  to  "say  them  to  the  grocer-man."  To  be 
suggestive  a  name  need  not  refer  to  the  product  it  iden- 
tifies. A  cigar,  for  example,  may  be  named  for  a  philan- 
thropist  \yho,  perhaps,  did  not  even  smoke  cigars ;  but  the 
suggestion  in  such  a  case  is  of  such  things  as  ease,  com- 
fort and  contemplative  thought — quite  worth-while  asso- 
ciations for  a  cigar  to  have. 

Little  need  be  said  of  the  folly  of  choosing  a  name 
which  is  difficult  to  pronounce,  or  the  attempt  to  pro- 
nounce which  may  cause  embarrassment,  as  in  the  case  of 
certain  French  and  other  foreign  names,  which  are  some- 
times followed  by  instructions  for  pronouncing.  One  of 
the  rules  of  modern  selling  is  to  make  everything  as  easy 
as  possible  for  the  buyer. 

Names  of  places,  descriptive  names,  or  words  found  in 
the  dictionary,  may  not  be  registered  as  trade-marks  or 
trade-names,  but  may  be  used  without  registration;  and 


SELLING  419 

if  priority  of  use  and  continued  use,  such  as  to  make  the 
name  of  the  article  more  important  than  the  name  of  the 
place  can  be  established,  the  user  is  protected  under  the 
law. 

The  package. — The  package  in  which  a  product 
appears  on  the  market  may  be  fully  as  worthy  of  careful 
attention  as  is  the  product  itself.  First  impressions  are 
likely  to  be  the  lasting  impressions.  We  pride  ourselves 
upon  our  quickness  of  judgment  and  hold  ourselves  ready 
for  a  surprisingly  long  time  to  return  to  our  "first  im- 
pression" of  an  article  or  a  person  and  prove  that  our 
initial  judgment  was  correct.  For  this  reason  alone  it  is 
worth  while  to  be  sure  that  the  package  makes  a  favor- 
able impression.  It  is  true  also  that  if  we  are  pleased 
with  the  way  in  which  the  product  has  been  presented  to 
us — by  the  advertisement,  the  salesman,  and  the  package 
— we  are  apt  to  find  the  product  itself  to  our  liking,  so 
strong  is  the  influence  of  suggestion. 

The  package  alone  may  be  an  advertising  medium  of 
first  importance,  if  the  advertising  thereon  is  restricted 
to  that  of  the  contents  of  the  package.  Women,  who  are 
commonly  believed  to  be  addicted  to  the  habit  of  "shop- 
ping."— going  out  to  buy  something,  without  knowing  be- 
forehand just  what  it  is  to  be — are  sure  to  be  attracted  by 
a  neat  or  otherwise  pleasing  package.  It  is  quite  permis- 
sible to  place  upon  a  package  various  advertisements  of 
kindred  products,  put  out  by  the  same  manufacturer  or 
dealer.  The  public  will  resent,  however,  the  use  of  the 
package  as  an  advertising  medium,  carrying  paid  adver- 
tisements. An  unfavorable  impression  is  made,  and  the 
idea  created  in  the  mind  of  the  buyer  that  it  is  his  money 


420  PRINCIPLES  OF  BUSINESS 

which  pays  for  the  advertisement,  whereas,  he  feels  that 
the  article  and  its  package  should  be  devoted  entirely  to 
the  purpose  for  which  he  has  paid  his  money. 

Besides  making  its  appeal  from  shelf  or  show  window, 
the  package  may  possess  features  of  real  convenience  to 
the  user.  It  would  be  difficult  to  estimate,  for  example, 
the  value  of  the  Colgate  tooth-paste  package,  from  which 
the  paste  "comes  out  like  a  ribbon  and  lies  flat  on  the 
brush." 

With  respect  to  the  convenience  of  the  package,  we 
might  learn  valuable  lessons  from  nature,  as  well  as  from 
the  manufacturers  of  artificial  products.  It  cannot  be 
doubted  that  the  banana,  for  example,  owes  not  a  little 
of  its  popularity  to  the  convenience  of  its  package.  The 
tgg,  also,  is  in  favor  quite  as  much  because  of  its  con- 
venient package  as  by  reason  of  its  intrinsic  qualities.  It 
will  be  observed,  moreover,  that  because  eggs  are  turned 
out  as  a  standardized  product  in  a  standard  package,  the 
selling  cost  is  very  low — that  is,  the  selling  price  is  but 
little  above  the  cost  of  production.  Production  is  stand- 
ardized, but  not  regularized,  but  this  disadvantage  is 
largely  offset  by  the  fact  that  the  supply  throughout  the 
year  is  equalized  by  means  of  cold  storage.  It  is. true 
that  standardization  in  size  is  not  thoroughly  satisfac- 
tory. The  public,  however,  generally  waives  this  point, 
although  here  and  there  there  may  be  one  of  us  who,  like 
the  miser  in  /  Promessi  Sposi,  measures  the  grocer's  eggs 
with  an  "egg-ring,"  rejecting  those  which  are  so  small 
that  they  will  pass  through. 

Determination  of  the  selling  price. — In  view  of  the 
considerations   mentioned   in   the   preceding  paragraphs, 


SELLING  421 

relating  to  the  study  of  the  product  itself,  and  in  view  of 
the  considerations  to  be  touched  upon  in  the  following, 
under  "Market  Analysis,"  the  selling  price  of  the  prod- 
uct must  be  determined,  together  with  the  terms  upon 
which  it  will  be  sold.  The  price  is  not  determined  pri- 
marily by  the  production  cost,  but  by  the  selling  cost, 
although,  of  course,  allowance  must  be  made  for  the  cost 
of  production  when  the  selling  price  is  decided  upon. 
Price  tends  to  approximate  production  cost  only  if  pro- 
duction be  taken  in  its  broadest  sense,  as  including  the 
delivery  of  the  article  to  the  consumer.  Price  fluctua- 
tions, as  will  be  apparent  to  any  observer,  are  out  of  all 
proportion  to  variations  in  the  cost  of  production ;  if  a 
rise  in  price  follows  a  rise  in  production  cost  it  will  be 
observed  that  the  amount  added  to  the  retail  price  is 
likely  to  be  several  times  the  amount  of  the  increase  in 
the  production  cost.  It  is  not  that  the  increase  in  the 
production  cost  itself  has  brought  about  the  whole  of  the 
increase  in  the  selling  price,  but  that  some  general  cost- 
increasing  factor  has  affected  production  cost  and  selling 
cost  at  the  same  time.  It  must  be  remembered  that  a 
dollar  added  to  the  cost  of  production  must,  under  the 
present  system  of  distribution,  in  which  it  is  uncertain, 
perhaps,  whether  the  article  will  ever  be  actually  sold  and 
paid  for,  be  represented  in  the  selling  price  by  much  more 
than  the  dollar  of  increase  in  the  production  cost. 

The  selling  price  is  usually  fixed  in  advance,  either  by 
the  producer  or  manufacturer  or  by  the  selling  organiza- 
tion. It  is  undoubtedly  an  advantage  in  economy,  tend- 
ing toward  a  standardization,  when  the  price  is  so  pre- 
determined. 


422  PRINCIPLES  OF  BUSINESS 

In  the  determination  of  what  the  price  shall  be  to  the 
consumer,  the  price  (or  cost)  to  the  producer  and  to  each 
intermediate  dealer  must  be  taken  into  consideration. 
These  dealers,  or  "middlemen,"  are,  in  present-day  busi- 
ness practice,  the  broker  or  merchant,  the  jobber,  and  the 
retailer.  The  broker  or  merchant  is,  practically,  the  sell- 
ing department  of  the  producer.  A  further  consideration 
of  the  different  classes  of  dealers  will  be  found  in  the 
chapter  on  "Distribution."  With  due  allowance  made 
for  the  various  elements  of  the  selling  cost,  the  price 
must  be  such  as  can  be  paid  by  the  class  of  consumers  for 
whom  the  product  is  intended.  If  the  article  cannot  be 
produced  and  sold  at  a  price  within  the  financial  means 
of  an  appropriate  class  of  consumers  it  is  useless  to  make 
it  or  to  try  to  sell  it.  Fortunately,  at  least  for  the  indi- 
vidual producer  or  dealer,  the  very  fact  that  an  article 
of  more  or  less  intrinsic  merit  may  necessarily  be  so  high 
in  price  as  to  place  it  out  of  the  reach  of  certain  classes 
creates  a  demand  for  it  among  consumers  in  a  wealthier 
class.  Food  products,  in  particular,  furnish  many  strik- 
ing examples  of  the  weakness  of  human  nature  indicated 
by  fact  above-mentioned.  When  bacon  was  cheap,  it 
was  regarded  as  a  poor  man's  food  and  despised  by  those 
who  could  afford  to  buy  what  the  poor  man  could  not 
afford.  Since  bacon  has  become  expensive,  it  is  regarded 
as  a  delicacy  by  rich  and  poor  alike. 

The  figure  decided  upon  as  the  selling  price  will  repre- 
sent not  the  highest  price  which  a  limited  number  of 
consumers  will  be  willing  to  pay.  unless  the  supply  of  the 
product  is  correspondingly  limited,  but  the  price  at  which 
the  greatest  number  of  sales  can  be  made,  consistent  with 


SELLING  '  423 

a  moderate  profit  upon  each.  The  greatest  aggregate 
profit,  as  a  rule,  resuhs  from  low  price,  rapidity  of  turn- 
over, large  volume  of  sales,  and  satisfied  consumers,  will- 
ing not  only  to  continue  their  purcliasing  of  the  article 
in  question  but  also  to  try  at  least  once  any  other  article 
which  the  seller  may  have  to  offer.  Such  conditions  as 
these  create  "good-will,"  the  most  valuable  asset,  usually, 
which  a  business  can  possess.  Even  a  virtual  monopoly 
will  find  itself  in  a  precarious  condition  if  it  neglects  the 
building  up  of  good-will. 

ANALYSIS  OF  THE  MARKET  n 

The  people  who  buy, — An  analysis  of  the  market  will 
be,  first,  of  the  consumers  who  may  be  induced  to  be- 
come customers.  A  study  of  these  potential  customers 
will  include  the  following: 

Where  do  they  live? — The  nature  of  the  product  will 
determine  the  extent  of  the  market,  and  whether  or  not  it 
can  be  enlarged.  The  market  may  be  world-wide,  na- 
tional, sectional  or  local.  Not  only  the  nature  of  the 
product  must  be  considered  in  respect  of  its  suitability  to 
the  needs  of  people  in  various  countries  and  climates,  but 
also  the  accessibility  of  the  market,  in  view  of  transpor- 
tation facilities  and  costs,  nationality  of  consumers — in- 
volving race  prejudices  or  customs,  or  difficulty  of  com- 
munication by  reason  of  language. 

An  interesting  illustration  of  the  overcoming  of  ob- 
stacles to  sales  to  foreign  consumers  is  the  experience  of 
a  well-known  automobile  company  which  was  opening 
up  its  market  in  Russia.  Their  cars  would  not  sell,  and 
it  was  discovered  almost  by  accident  that  the  reason  was 


424  PRINCIPLES  OF  BUSINESS 

that  they  were  painted  black — a  color  associated  with 
funerals.  A  change  in  the  color  of  the  paint  made  sales 
comparatively  easy.  A  typewriter  company,  profiting  by 
the  experience  of  the  automobile  company,  likewise 
painted  its  product  in  bright  colors,  enlarged  its  key- 
board to  fit  the  Russian  fingers,  and  almost  immediately 
found  itself  with  a  profitable  market. 

Climatic  conditions  must  be  taken  account  of.  The 
maker  of  overcoats,  presumably,  may  eliminate  the  resi- 
dents of  tropical  countries  from  hi«  market  altogether. 
While  he  may  expect  to  sell  a  few  overcoats  a  little  far- 
ther from  the  equator,  where  the  winter  is  colder,  it 
would  not  pay  him  to  do  a  great  amount  of  advertising 
except  much  farther  north  or  south,  where  overcoats 
are  worn  during  a  considerable  portion  of  the  year. 

Environment. — A  study  of  where  the  consumers  live 
involves  further  the  question  of  whether  they  are  resi- 
dents of  city,  suburbs,  town,  or  country.  The  population 
of  a  sales  district  or  territory  is  of  great  importance,  but 
not  of  more  importance  than  the  distribution  of  the  popu- 
lation. The  maker  of  acetylene  or  electric  generators 
for  individual  home-lighting  plants  may  disregard  the 
dwellers  in  cities,  so  far  as  market  is  concerned.  He  is 
interested  in  the  rural  population — the  number  of  well- 
to-do  farmers  and  ranchmen  in  the  district,  or  the  number 
of  country  estates  belonging  to  wealthy  residents  of 
cities. 

Class  of  buyers. — It  must  be  ascertained  also,  in  a 
given  district,  whether  the  inhabitants,  as  a  class,  are  rich 
or  poor,  what  their  occupations  are,  and  how  they  may 
be  reached  and  influenced.     The  nature  of  the  article  in 


SELLING  42s 

its  relation  to  the  classes  of  buyers  will  also  be  considered 
in  this  connection — whether  the  buyers  are  likely  to  be 
influenced  by  other  people,  and  whether  the  buyers,  for 
the  most  part,  are  men,  women  or  children.  Some  ar- 
ticles must  be  sold  practically  by  a  separate  appeal  to 
each  consumer,  while  with  others  it  is  sufficient  if  a  few 
influential  consumers  will  set  the  fashion  of  using  it. 

Buying  habits. — Finally,  the  habits  of  the  buyers  will 
be  investigated — whether  they  buy  in  large  or  small  quan- 
tities at  a  time,  whether  they  usually  pay  cash  for  their 
purchases  or  expect  credit,  and  whether  they  buy  from 
dealers  or  from  the  manufacturer  direct.  Each  of  these 
questions,  of  course,  may  have  to  be  answered  separately 
with  respect  to  each  product  or  class  of  products  con- 
sumed. 

Competition. — In  order  to  determine  the  probable 
competition  that  must  be  met,  these  general  market  con- 
ditions will  first  be  ascertained :  ( i )  the  total  consump- 
tion, (2)  whether  consumption  per  capita  is  increasing  or 
decreasing,  (3)  whether  the  market  (i.e.,  number  of  con- 
sumers) is  expanding  or  contracting,  and  (4)  whether  or 
not  the  market  is  saturated — that  is,  what  the  supply  is 
compared  with  the  demand. 

Next,  the  competitors  themselves  will  be  considered 
(i)  as  to  their  number,  (2)  their  resources  and  (3)  the 
location  of  their  establishments.  More  detailed  informa- 
tion will  also  be  secured,  so  far  as  possible,  relating  ( i ) 
to  their  aggressiveness,  (2)  their  standing  with  the  pub- 
lic (good-will)  and  (3)  their  marketing  methods.  These 
last  will  include  (i)  their  selling  methods  (whether  they 
sell  through  dealers,  or  directly  to  consumers),   (2)  the 


426  PRINCIPLES  OF  BUSINESS 

prices  at  which  their  products  are  sold  to  dealers  and 
consumers,  (3)  their  margins  of  profit,  and  (4)  their 
terms  of  sale  (whether  they  sell  for  cash  or  on  credit,  and 
if  on  credit,  upon  what  terms). 

The  products  of  competitors,  of  course,  will  be  studied 
with  the  greatest  care,  with  a  view  to  ascertaining  their 
merits  as  well  as  their  defects,  ( i )  intrinsic  and  (2)  from 
the  point  of  view  of  the  consumer.  The  attitude  of  the 
public  toward  any  article  is  not  always  a  positive  indica- 
tion of  merit  or  the  opposite.  The  public  may  be  satis- 
fied with  an  inferior  article,  not  having  had  experience 
with  a  better;  or  may  be  dissatisfied  with  a  really  good 
article  which  has  some  easily  correctible  defect.  Many 
a  sales  agent  has  pondered  long  and  earnestly  over  why 
his  product  would  not  "take,"  and  eventually  found  the 
explanation  so  obvious  that  it  had  been  overlooked.  It 
is  often  the  case  that  a  device  which  seems  excellent  to 
the  makers  and  to  the  management  of  the  concern  that 
installs  it  will  prove  a  failure,  the  reason  for  which  re- 
mains a  mystery  until  the  explanation  is  found  in  the 
attitude  of  the  employees,  who  may  be  prejudiced  against 
it,  as  threatening  to  do  away  with  some  of  their  jobs, 
or  who  may  find  its  use  disagreeable. 

It  is  scarcely  necessary  to  note  that  the  study  of  the 
products  of  competitors,  while  it  may  afford  an  oppor- 
tunity for  putting  out  an  improved  product  or  an  equally 
good  one  at  a  lower  price,  is  not  to  be  made  with  the  ob- 
ject of  finding  an  opportunity  for  "knocking."  The  con- 
sumer resents  any  reflection  upon  the  judgment  he  has 
displayed  in  purchasing  from  competitors.  If  he  has  not 
yet  purchased,  he  resents  the  suggestion  that  he  might 


SELLING  427 

display  bad  judgment  in  the  future.  In  fact,  the  con- 
sumer, about  to  part  with  his  money,  is  often  anxious  to 
find  something  to  resent,  and  is  in  a  dangerous  mood. 
Moreover,  "knocking"  a  competitor's  goods  is  a  confes- 
sion of  fear — and  if  there  is  one  impression  above  all 
others  that  the  salesman  should  create,  it  is  that  he  is 
confident  of  himself  and  his*  goods  and  that  he  has  no 
reason  to  be  afraid  of  his  competitors. 

Transportation  in  its  relation  to  the  market. — 
Transportation  facilities  and  costs  have  much  to  do  with 
the  extent  of  the  market,  and  are  also  a  factor  in  the  sell- 
ing price  of  the  product.  The  disturbance  between  supply 
and  demand  caused  by  the  European  War  provided  an 
object  lesson  in  the  importance  of  transportation.  Price 
movements  alone  were  incapable  of  bringing  about  adjust- 
ments. The  problem  of  production  was  seen  to  be  no 
greater  than  that  of  transportation.  Both  w^ere  equally 
vital,  but  in  that  emergency  it  was  easier  to  secure  ample 
production  than  adequate  transportation.  There  was 
plenty  of  coal  at  the  mines,  and  plenty  of  sugar  in  Java; 
but  there  were  not  enough  cars  and  not  enough  ships. 
Production  itself  was  in  a  large  measure  dependent  upon 
transportation,  with  respect  to  raw  materials  and  fuel. 

The  phases  of  the  problem  to  be  considered  in  an  analy- 
sis of  transportation  facilities  in  their  relation  to  the 
market  will  include  the  following : 

I.  What  are  the  transportation  facilities? 
a.   Railroads  or  trolley  lines 
k   Highways 

c.  Present  condition  of  transportation  facilities 

d.  Means  of  extension,  if  necessary 


428  PRINCIPLES  OF  BUSINESS 

e.  Storage  at  terminal 

f.  Stability  of  transportation  service 

2.  Time  required  in  transportation? 

a.  Service  to  consumers;  promptness  of  delivery 

b.  Perishable  products 

( 1 )  Deterioration  or  injury  in  long  haul 

(2)  Icing  or  otlier  attention  in  transit 

(3)  Estimates  of  the  condition  of  the  mar- 

ket upon  arrival  of  goods  where  tran- 
sit is  long 

3.  Rates? 

a.  Freight 

b.  Express 

c.  Parcels  post 

4.  Cost  of  crating  and  handling? 

5.  Cost  of  reclaiming  rejected  shipments? 

6.  Competition? 

a.  Of  local  producers 

b.  Of  producers  at  a  distance 

( 1 )  Their  production  facilities 

(2)  Their  transportation  facilities,  including 

rates 
Other  questions  which  will  arise  are :  Regardless  of 
competition,  will  the  addition  of  transportation  charges 
to  other  costs  make  the  price  of  the  goods  too  high  ?  At 
what  selling-price  will  the  market  vanish?  Rather 
closely  connected  with  the  question  of  transportation  it- 
self is  that  of  the  organization  often  required  for  han- 
dling goods  at  their  destination.  Is  the  market  at  the  des- 
tination large  enough,  or  profitable  enough,  to  justify  the 


SELLING  429 

necessary  sales  organization  at  that  point?     Is  the  de- 
mand constant,  or  seasonal,  or  only  temporary  ? 

The  broader  aspects  of  the  transportation  problem  will 
be  considered  in  the  chapters  on  "Traffic."  Other  phases 
will  be  touched  upon  incidentally  under  "Distribution." 


CHAPTER    XIX 

SELLING 

(Continued) 

SALESMANSHIP 

What  is  meant  by  salesmanship? — The  word  "sales- 
manship" is  comparatively  new  in  our  vocabulary.  It  is 
not  found,  for  example,  in  Webster's  Unabridged  Dic- 
tionary of  1900.  Its  use  or  meaning  has  therefore  not 
as  yet  become  standardized.  New  words  are  often  over- 
worked, and  it  is  probable  that  this  one  has  been.  We 
shall  not  go  far  astray,  however,  if  we  define  the  term 
"salesmanship''  as  including  no  more  and  no  less  than: 
any  means,  direct  or  indirect,  by  which  it  is  sought  to 
induce  or  persuade  a  given  individual  or  association  of 
individuals  to  purchase  a  given  article. 

Salesmanship  as  distinguished  from  advertising. — 
Sales  appeals,  however  specific,  which  are  based  on  a  gen- 
eral formula  and  into  which  the  element  of  personality 
does  not  enter,  as  between  the  buyer  and  the  seller,  must 
be  classed  as  advertising  and  not  salesmanship.  Cer- 
tainly, the  seller  may  put  his  own  personality  into  a  sales 
appeal,  but  it  still  must  be  classed  as  advertismg  unless 
the  personality  of  some  particular  buyer  is  taken  account 
of  as  a  factor  in  the  prospective  sale.  When  we  use  the 
word  "individual"  in  this  connection  we  mean  one  who  is 
an  individual  from  the  standpoint  of  the  seller — a  possible 

430 


SELLING  431 

buyer  about  whom  something  is  known.  The  sending 
out  of  a  set  of  form  letters,  for  example,  would  be  adver- 
tising, even  if  those  to  whom  the  letters  were  addressed 
had  been  carefully  selected,  with  respect  to  their  occupa- 
tions and  ratings.  If,  however,  the  sender  of  the  letters 
should  say :  "We  had  better  mail  one  of  these  letters  to 
Jones  in  Blankville — this  is  just  the  kind  of  thing  that 
would  interest  him" — that  would  be  an  act  of  salesman- 
ship. The  salesman  always  aims  at  a  definite  mark,  and 
not  at  individuals  in  the  mass,  as  does  the  advertiser. 

Selling  in  its  broader  sense  is  a  matter  of  pohcies  de- 
duced from  statistics.  Advertising  is  that  branch  of  sell- 
ing which  is  devoted  chiefly  to  the  upbuilding  of  good-will. 
Salesmanship  proper  is  a  matter  chiefly  of  the  personal 
relationships  involved  in  selling. 

The  basis  of  successful  salesmanship. — There  are 
several  psychological  elements  which  are  necessary  to  a 
•  sale,  and  the  most  vital  of  them  all  is  confidence.  Con- 
fidence usually,  but  not  necessarily,  connotes  integrity,  or 
honesty;  but,  strictly  speaking,  the  confidence  which 
forms  the  basis  of  successful  salesmanship  is  no  more 
than  mutual  understanding.  Salesmanship,  like  any 
other  art  or  science,  may  be  used  for  unethical  purposes. 
Chemistry  is  none  the  less  chemistry,  even  if  it  produces 
an  anarchist's  bomb.  When  the  burglar  goes  out  to  sell 
his  plunder,  he  does  not  go  to  an  honest  dealer.  Neither 
does  he  attempt  to  create  the  impression  that  he  himself 
has  come  by  the  jewels  honestly.  He  goes  to  someone 
in  whom  he  has  "confidence"  and  who  has  confidence  in 
him.  The  seller  and  the  buyer  have  confidence  in  each 
other,  in  the  sense  that  each  knows  what  the  other  mav 


432  PRINCIPLES  OF  BUSINESS 

be  expected  to  do  under  given  conditions,  and  what  things 
must  be  guarded  against. 

Confidence  grows  out  of  mutual  understanding,  and 
mutual  understanding  results  from  associations  in  com- 
mon. The  nature  of  our  instinctive  reactions  toward 
what  we  do  not  understand  is  well  expressed  in  the  well- 
known  line  from  Punch — "  'E's  a  stranger !  'Eave  'arf  a 
brick  at  'im." 

Examples  of  mutual  associations  which  assist  the  sales- 
man in  gaining  the  confidence  of  the  buyer  may  be  found 
in  the  following: 

1.  NationaHty;  place  of  birth  or  residence;  mutual 
friends  or  membership  in  the  same  organization;  college 
and  other  similar  associations. 

2.  Occupation,   social  standing,   financial  condition.  ' 

3.  Personal  appearance,  taste  as  to  clothes  and  decora- 
tive jewelry;  habits,  propensities,  beliefs;  intellectual  pur- 
suits, hobbies,  and  the  like. 

The  pleasure  of  recognition,  the  community  of  interest, 
the  pleasing  tribute  to  our  own  tastes  and  judgments 
growing  out  of  any  of  the  above  may  bring  the  salesman 
far  on  his  way  to  the  securing  of  our  favorable  attention. 
The  onrush  of  sympathy  which  we  instinctively  feel  if 
any  of  these  conditions  are  favorable  will  itself  tend  to 
inhibit  the  inhibitions  which  might  otherwise  arise  to 
interfere  with  the  sale. 

This,  then,  is  the  foundation  of  successful  salesmanship 
— the  winning  of  the  buyer's  confidence,  leading  to  an 
establishment  of  identity  of  interest.  Salesmanship,  as 
a  science,  has  nothing  to  do  with  ethics.  .Unethical  busi- 
ness methods  with  unethical  salesmanship,  however,  tend 


SELLING  433 

towards  being  eliminated  as  a  result  of  non-support  on  the 
part  of  the  public  and,  for  practical  purposes,  may  be  dis- 
regarded. 

While  we  are  so  close  to  the  subject,  it  may  be  well  for 
us  to  pause  to  consider  the  much-talked-of  element  ot 
"character"  in  salesmanship,  which  is  often  urged  as  the 
greatest  factor  in  success — "character"  being  used,  as  we 
may  use  it  here,  in  its  colloquial  sense,  signifying  honesty 
or  moral  uprightness.  Character  is  a  necessity  in  busi- 
ness, but  why  may  it  not  be  taken  for  granted?  Hon- 
esty is  not  something  which  can  be  adopted  as  a  policy. 
Either  a  man  is  honest,  or  he  is  not.  It  happens  that 
only  honest  men  are  likely  to  be  successful  in  business,  but 
honesty  itself  has  as  many  patrons  in  the  poor-house  as 
dishonesty  has  in  the  penitentiary.  When  dishonesty  in 
the  world  of  business  shall  at  length  have  died  of  malnu- 
trition, honesty,  as  we  now  understand  it,  will  no  longer 
have  any  meaning.  We  cannot  conceive  of  any  quality 
unless  there  is  an  opposite  with  which  it  can  be  compared. 
When  honesty  or  "character"  has  thus  disappeared,  what 
will  then  be  the  basis  of  salesmanship?  It  will  be  then 
what  it  is  now — confidence,  or  mutual  understanding. 

Making  a  sale. — Prepared  to  gain  the  confidence  of 
the  buyer,  "representing"  goods  which  the  buyer  needs, 
how  does  the  salesman  actually  effect  a  sale? 

There  are  commionly  said  to  be  four  stages  in  a  sale — 
the  pre-approach,  the  approach,  the  demonstration,  and 
the  close.  The  corresponding  psychological  states  to  be 
induced  in  the  purchaser  are  attention,  interest,  desire, 
and  action.  These,  built  upon  the  basis  of  confidence, 
may  be  shown  by  the  following  chart: 


434  PRINCIPLES  OF  BUSINESS 


PRE-APPROACH 

attention 

APPROACH 

interest 

DEMONSTRATION 

DESIRE 

CLOSE 

action 

confidence 

(ability  to  ovt;rcome  inhibitions) 

...                   -               -                                  ......... 

Attention. — The  salesman's  first  step  in  making  a  sale 
is  to  attract  and  secure  the  favorable  attention  of  the 
buyer.  Attention  should  be  obtained  by  means  of  some- 
thing relevant  to  the  prospective  sale.  If  the  buyer's 
attention  is  diverted  from  the  article  itself,  it  must  be 
brought  back  again;  but  there  is  always  the  danger  that 
the  buyer  will  resent  anything  that  savors  of  a  salesman's 
trick  of  catching  the  attention.  Attention  must  be 
directed  to  the  article,  and  not  to  the  salesman  himself. 

Harold  Whitehead  tells  of  how  an  insurance  salesman 
secured  the  attention  of  a  difficult  "prospect."  ^ 

Now   I'll   recount   Perkins's   story  of  his  best  life-insurance  sale. 

It  seems  that  he  had  been  planning  to  sell  insurance  to  a  real 
estate  man  for  a  long  time.  He  knew  the  man  was  doing  a  land 
office  business  and  was  carrying  only  about  $5,000  worth  of  insur- 
ance. 

Now  if  he  approached  Barnum  (the  real  estate  man)  and  talked 
insurance,  he  knew  he  would  fall  through  before  he  commenced, 
so  he  skirmished  around  for  a  month  or  more  studying  his  man. 

When  Perkins  was  all  ready  he  called  on  Barnum  and  said: 
"Mr.  Barnum,  I've  called  to  see  you  about  your  business  rating. 
I've  discovered   it  isn't  correct." 

Can  you  guess  what  happened?  You're  right.  Barnum  blew  up  I 
He  evidently  thought  Perkins  was  a  credit  reporter  or  something 
like  that.  He  guessed  his  rating  was  right,  and  no  one  could  say 
he  padded  his  assets  and  get  away  with  it. 

1  "The  Business  Career  of  Peter  Flint,"  New  York  Evening  Sun, 
June  18,  1918. 


SELLING  435 

"You  misunderstand  me,  Mr.  Barnum,"  said  Perkins.  "You 
haven't  padded  your  assets  at  all,  but  you've  grossly  underestimated 
one  item  of  yours." 

Of  course  Barnum  cooled  off  at  that  and  asked,  "What  item?" 

"Let  me  ask  you,  Mr.  Barnum,"  parried  Perkins,  "are  you  per- 
sonally responsible  for  your  remarkable  success  or  do  you  owe  it 
to  a  manager  or  some  one?" 

"There's  only  one  man  responsible  for  Barnum's  getting  on  in 
the  world  and  that's  Barnum,"  was  his  boastful  reply. 

"It's  as  I  thought,"  came  back  Perkins,  "and  yet  in  your  assets 
you  value  the  most  important  item  you  have  at  only  $5,000.  You 
give  the  world  a  false  impression  of  yourself  when  you  place  such 
a  paltry  figure  on  yourself." 

"Five  thousand  dollars?  Important  asset?  Me?"  Mr.  Barnum 
hadn't  tumbled. 

"What    do   you    mean,    anyhow?" 

"Just  this."  Here  Perkins  hitched  his  chair  a  bit  nearer  Bar- 
num. "You  carry  only  $5,000  worth  of  insurance,  thus  placing 
that  sum  as  your  estimate  of  your  value.  Five  hundred  thousand 
would  be  nearer  the  mark." 

"Lordy,"  said  Barnum  in  admiration.  "You're  a  life  insurance 
agent,  ain't  you?" 

"Correct,"  Perkins  smiled. 

"Why  didn't  you  say  so  at  first?" 

"What  would  you  have  done  if  I  had?" 

"Guess  I'd  have  terminated  the  interview." 

"Exactly,  and  by  so  doing  you  would  have  been  deprived  of 
knowing  how  you  were  doing  yourself  an  injustice.  Mr.  Barnum, 
you  can't  afford  to  put  yourself  in  a  poor  light  with  the  world  any 
longer.  Never  mind  amounts  now ;  will  you  see  the  doctor  in  the 
morning?" 

Barnum  looked  at  Perkins  in  open  admiration. 

"A  life  insurance  agent!  Say,  you  ought  to  be  in  the  real  estate 
business ;  you're  too  good  to  be  peddling  insurance." 

"Thanks.     But  how  about  the  doctor  for  tomorrow?" 

"Bring  him  around,  son;  you've  sold  me,  all  right.  I  guess  I 
ought  to  have  more  insurance  and  I  can't  dodge  the  logic  of  your 
sales  talk. 

"He  isn't  my  biggest  policyholder,"  mused  Perkins  in  conclusion, 
"but  I  got  him  for  $85,000." 

A  spectacular  pre-approach,  of  course,  is  to  be  striven 

for  only  in  exceptional  circumstances.     If  it   fails,  the 

sale  is  lost,  for  the  salesman  has  ceased  to  "dominate"'  the 

situation,  and  when  that  happens  he  may  as  well  take  his 

hat  and  go. 

Interest. — The  interest  of  the  buyer  should  at  first  be 


436  PRINCIPLES  OF  BUSINESS 

a  rather  impersonal  interest.  The  salesman  in  his  "ap- 
proach" carefully  restrains  the  buyer  from  considering 
the  purchase  of  the  article.  If  the  buyer's  private  deci- 
sion should  be  unfavorable,  which  at  this  Stage  it  prob- 
ably would  be,  there  has  been  created  an  additional 
obstacle  to  be  overcome.  The  salesman's  object  is  to  pre- 
vent the  buyer  from  saying  "no"  until  he  is  ready  to  ask 
him  to  say  "yes." 

"This  motor,"  he  may  say,  "runs  so  quietly  that  you 
can  drive  onto  a  ferry-boat  and  leave  it  running,  and 
they'll  never  know  the  difference.  *  *  *  A  doctor  was 
looking  at  this  car  the  other  day  and  the  only  way  he 
could  tell  whether  the  motor  was  running  or  not  was  by 
using  a  stethoscope  *  *  *  And  as  for  speed,  I  was  out 
with  it  last  night  and  a  motor-cop  chased  me  for  three 
miles.  He  finally  overtook  me,  and  I  thought  I  was 
arrested,  but  he  said  all  he  wanted  was  permission  to  raise 
the  hood  and  take  a  look  at  that  engine.  Worth  looking 
at,  too,  for  although  it  is  not  generally  known,  our  en- 
gineers really  designed  the  Liberty  Motor." 

The  salesman,  then,  devotes  the  part  of  the  interview 
known  as  the  approach  primarily  to  giving  the  customer 
an  adequate  and  favorable  idea  of  the  article  he  is  selling 
and  to  overcoming  any  prejudices  or  misapprehensions 
that  may  exist  in  the  customer's  mind.  He  must  fore- 
stall unfavorable  criticism  and  answer  objections,  if  pos- 
sible, before  they  are  formulated  or  crystallized.  The 
customer  must  be  led  to  acquiesce  in  the  salesman's  opin- 
ion of  the  goods — that  they  are  something  of  real  merit, 
as  the  customer  can  see  for  himself — that  everyone  of 
equally  discriminating  judgment  comes  to  the  same  con- 


SELLING  437 

elusion — that  this  opinion  is  proved  correct  by  the  satis- 
faction of  those  who  have  actually  used  the  goods. 

Desire. — Following  the  arousing  of  the  customer's  in- 
terest in  the  goods  as  being,  in  the  abstract,  something  of 
genuine  merit,  and  useful  to  other  people,  the  salesman 
will  deftly  lead  the  customer  to  a  consideration  of  what 
their  value  to  himself  would  be. 

"Take  the  wheel,"  he  will  say.  "Drive  the  car  your- 
self." Ostensibly  the  purpose  is  to  let  the  customer  be 
convinced  of  the  ease  with  which  the  machine  may  be 
driven,  how  it  responds  to  pressure  on  the  throttle.  The 
primary  appeal,  however,  is  to  the  old  instinct  of  posses- 
sion, which  leads  us  to  hold  what  we  have.  The  "pros- 
pect," his  hand  on  the  wheel  and  his  foot  on  the  throttle, 
passing  friends  or  acquaintances  who  recognize  him,  feels 
himself  to  be  the  owner  of  the  car,  identifies  himself  with 
its  possession.  He  begins  to  plan  what  outings  he  and 
his  family  and  his  friends  might  take  in  a  nice-looking 
car  like  this — a  car  that  no  one  would  need  to  be  ashamed 
of — so  easy,  too,  on  tires  and  gasoline. 

The  salesman  now  begins  to  watch  for  the  moment  at 
which  to  force  a  favorable  decision.  The  customer  may 
not  be  aware  of  it,  but  at  this  stage  of  the  sale  he  is  under 
the  very  closest  observation. 

Action. — The  close  of  the  sale  is  the  most  difficult  part. 
There  are  many  salesmen  who  can  guide  the  "prospect" 
successfully  through  the  preceding  psychological  stages, 
but  when  the  time  comes  to  get  action,  they  fail. 

Here,  in  particular,  it  is  vital  that  the  salesman  "dom- 
inate the  situation."  To  induce  action,  there  must  be 
action,  or  imitation  of  action.     This  necessary  action  or 


438  PRINCIPLES  OF  BUSINESS 

semblance  of  action  is  likely  to  seem  forced  and  unnat- 
ural^ and  to  be  ineffective  in  its  purpose,  unless  the  sales- 
man is  able  to  maintain  an  appearance  of  ease  and  con- 
fidence, commonly  known  as  "poise."  Poise  is  largely 
a  matter  of  birth  and  breeding,  especially  in  social  rela- 
tionships. In  business  relationships,  however,  it  is  prob- 
able that  poise  results  primarily  from  self-confidence  and 
familiarity  with  the  task  in  hand.  Self-confidence  should 
come  with  a  thorough  knowledge  of  the  goods  and  a 
conviction  that  they  are  really  needed  by  the  prospective 
purchaser.  Without  such  a  knowledge  and  conviction 
there  should  be  no  attempt  to  make  the  sale.  Thinking 
primarily  of  the  service  which  he  is  performing  for  the 
buyer,  and  not  of  the  profit  which  he  himself  is  to  make 
on  the  sale,  and  with  the  familiarity  with  the  task  which 
results  from  a  reasonable  amount  of  practice,  the  sales- 
man should  be  able  to  acquire  the  poise,  or  ease  of  man- 
ner, which  is  indispensable. 

Why,  it  may  be  asked,  is  poise  so  vital  an  attribute  of 
the  salesman?  It  is  because  lack  of  poise,  of  self-control, 
indicates  uncertainty,  and  arouses  the  buyer's  suspicion. 
It  diverts  the  buyer's  attention  from  the  goods  to  the 
salesman  himself,  or  disperses  it  in  every  direction.  If 
the  situation  is  at  all  critical,  the  sale  is  almost  certain 
to  be  "killed."  If  confidence  is  contagious,  doubt  is  also 
contagious,  and  more  so. 

Wherever  two  or  three  are  gathered  together  in  the 
name  of  business  or  anything  else,  there  is  one  dominating 
personality,  one  to  whom  the  others  look  for  initiative 
and  leadership.  Other  things  being  equal,  this  man  is 
the  one  who  knows  more  than  the  rest 


SELLING  439 

Many  a  salesman  has  lost  control  of  the  interview  and 
lost  his  sale  by  not  knowing  more  about  his  goods  than  his 
"prospect"  knew.  There  are  elements  of  interest  in  every 
article  or  product.  Why  should  not  the  salesman  learn 
them — each  of  them — and  use  them  as  a  means  of  holding 
the  buyer's  attention — of  continuing  to  "dominate"  the 
interview  ?  The  average  buyer  is  willing  to  listen  only 
as  long  as  he  can  learn  something  worth  knowing;  he  is 
interested  not  at  all  in  the  salesman's  personal  prejudices 
and  preferences. 

A  customer  entered  a  "men's  furnishing"  store  to  buy  a 
collar.  The  salesman  called  his  attention  t»  two  brands- 
— the  "Lion,"  and  the  "Tiger." 

"The  'Tiger'  is  what  I  wear  myself,"  remarked  the 
salesman. 

"Then  I'll  take  the  'Lion',"  answered  the  customer. 

The  salesman  and  the  purchasing  agent. — A  thor- 
ough knowledge  of  his  goods  has  become  more  than  ever 
necessary  to  the  salesman  as  a  result  of  the  development 
of  a  comparatively  new  business  "profession" — that  of  the 
purchasing  agent. 

The  purchasing  agent  is  influenced  not  by  suggestion, 
but  by  facts.  He  has  made  a  scientific  study  of  his  re- 
quirements ;  he  has  on  file  the  specifications  and  prices  of 
competing  goods.  He  takes  into  consideration  not  only 
the  intrinsic  merit  of  the  coods  but  also  the  "dependa- 
bility" of  the  house  that  offers  them. 

Each  sale  a  problem  in  itself. — It  is  not  to  be  in- 
ferred from  the  foregoing  that  it  is  possible  to  lay  down 
any  fixed  rules  covering  tlie  psvchology  of  selling.  The  four 
stages  through  which  the  salesman  takes  his  customer  are 


440  PRINCIPLES  OF  BUSINESS 

not  at  all  clearly  defined,  and  methods  may  vary  with 
every  case.  About  all  that  can  be  said,  with  reference  to 
technique,  is  that  favorable  attention  must  be  secured, 
that  the  customer's  interest  must  be  held  while  the  merits 
of  the  goods  are  explained,  that  it  is  inexpedient  to  allow 
an  opportunity  even  for  a  tentative  decision  until  all 
the  arguments  are  set  forth,  and  that  finally,  when  the 
moment  arrives,  action  must  be  secured. 

"The  selling  talk." — It  has  been  found  advantageous 
to  put  salesmen  through  a  course  of  preparatory  training 
before  they  go  out  to  sell,  during  which  course  of  train- 
ing they  learn  the  essential  facts  about  the  goods  they 
are  to  handle  and  the  policies  of  the  house,  and  during 
which  also  they  must  become  letter-perfect  in  a  "stand- 
ard selling  talk."  In  actual  practice,  of  course,  the  sales- 
man may  vary  or  modify  his  selling  talk  to  suit  the  needs 
of  each  particular  case,  but  having  in  memory  a  ready 
answer  to  each  possible  objection  and  a  condensed  pres- 
entation of  each  desirable  quality  of  the  product  enables 
the  salesman  to  give  more  attention  to  the  customer,  while 
making  a  sale,  and  less  attention  to  himself.  He  does 
not  run  the  risk  of  losing  control  of  the  situation  by 
finding  himself  suddenly  at  a  loss  for  the  right  thing  to 
say. 

Argument  and  suggestion. — As  is  pointed  out  by 
Walter  Dill  Scott,  in  his  excellent  book,  Influencing  Men 
in  Business,'^  both  argument  and  suggestion  are  effective 
in  influencing  men — argument  being  required  in  the  ex- 
ploiting of  anything  new  or  unusual,  and  also  in  selling 
to  professional  buyers.     Furthermore,   argument  is  es- 

1  Ronald   Press   Company,   New   York,   iQll. 


SELLING  441 

sential  where  the  amount  to  be  spent  is  an  appreciable 
portion  of  the  buyer's  total  wealth.  Argument  is  also 
needed  to  induce  men  to  change  their  customs  or  habits. 

Suggestion,  however,  is  preferable  when  the  amount 
involved  is  small,  in  the  sense  that  the  expenditure  will 
not  be  felt ;  when  immediate  action  is  required,  and  there 
is  no  time  for  argument  ;^nd  in  securing  action  follow- 
ing conviction.  Incidentally,  suggestion  has  been  found 
more  effective  than  argument  in  dealing  with  the  general 
public,  as  in  advertising.  This  is  probably  due  to  the 
fact  that  it  is  difficult  to  secure  the  attention  of  the  public 
for  a  time  sufficient  in  which  to  present  an  argument. 

Management  of  salesmen. — The  management  of 
salesmen  is  so  closely  connected  with  salesmanship  itself 
that  it  may  not  be  amiss  to  include  it  under  the  present 
caption.  Not  only  must  the  sales  manager  assist  the 
salesman  in  solving  many  of  his  problems,  but,  in  a  sense, 
the  goods  themselves  must  be  sold  to  the  salesman  before 
he  is  able  to  resell  them  to  the  public. 

The  first  thing  to  do  in  preparing  the  salesman  for  his 
task  is  to  present  the  products  of  the  house  to  the  sales- 
man with  such  sincerity  and  effectiveness  that  if  the  sales- 
man had  a  personal  need  for  such  goods  he  would  use 
them  himself  in  preference  to  any  other.  Persuading  the 
salesman  to  a  thorough  "belief  in"  the  goods  he  is  to 
sell  is  undoubtedly  itself  a  form  of  salesmanship.  In 
fact,  practically  all  the  elements  of  salesmanship  are  to 
be  found  in  this  preliminary  selling  to  the  salesman.  His 
interest  must  be  secured  and  held;  a  knowledge  of  the 
origin  and  uses  of  the  goods  must  be  imparted  to  him; 
of  how  they  may  be  secured;  of  their  value,  and  of  the 


442  PRINCIPLES  OF  BUSINESS 

value  to  himself  of  being  connected  with  an  organization 
for  their  sale  and  distribution;  being  convinced  of  all 
these,  he  must  be  led  to  accept  the  offer,  and  to  cast  in 
his  lot  with  the  house  in  a  spirit  of  whole-hearted  loyalty. 
This  is  the  very  essence  of  salesmanship. 

The  sales  organization. — If  the  field  of  business  were 
a  battleground  (which  in  son^  respects  it  is  and  which 
in  other  respects  it  is  not),  it  might  be  said  that  the  sales- 
men are  the  troops  in  the  front-line  trenches.  The  heavy 
guns  of  advertising  may  blast  the  way,  and  the  house  let 
down  a  protecting  barrage — but,  after  all,  it  is  the  sales- 
man who  goes  over  the  top  and  meets  the  enemy  face  to 
face.  The  problem  of  the  sales-manager,  accordingly,  is 
to  dispose  his  strongest  troops  where  the  consumers  are 
lodged  in  the  greatest  numbers,  and  to  give  his  troops  the 
necessary  support. 

In  a  typical  sales  organization,  the  logical  market  hav- 
ing been  ascertained  by  a  study  of  relevant  statistics  (the 
extent  of  the  market  depending  upon  the  amount  of  goods 
to  be  sold,  transportation  facilities  and  other  considera- 
tions), the  market  will  be  divided  into  districts,  divisions, 
and  territories.  Other  things  being  equal,  the  location  of 
headquarters  in"  these  subdivisions  of  the  market  will  be 
upon  the  basis  of  population  and  not  of  geography.  Ac- 
tual conditions  with  respect  to  population  or  theoretical 
consumption  of  the  different  sections  of  the  country  will 
be  visualized  with  the  aid  of  a  map  upon  which  each 
State,  county,  or  other  subdivision  of  the  total  sales  terri- 
tory is  reduced  or  expanded  to  indicate  its  relative  im- 
portance with  respect  to  population  or  consumption,  ac- 
tual or  potential,  of  the  products  to  be  sold.     Each  dis- 


SELLING  443 

trict,  under  a  district  manager,  with  headquarters  at  a 
strategic  point  in  the  district,  is  cut  up  into  divisions  and 
each  division  into  territories,  with  a  salesman  to  each 
territory.  The  size  or  number  of  these  divisions  depends 
upon  the  number  of  salesmen  each  division  manager  can 
supervise,  since  it  is  essential  that  the  division  manager 
keep  in  very  close  touch  with  the  work  of  each  individual 
salesman.  As  the  volume  of  sales  increases  and  terri- 
tories are  split  up  and  more  salesmen  employed,  a  new 
division  must  be  created  whenever  the  number  of  sales- 
men is  increased  to  the  point  where  the  division  manager 
can  no  longer  keep  in  sufficiently  close  touch  with  their 
activities. 

Leads. — "Leads"  are  items  of  information  concerning 
consumers  who  may  be  turned  into  customers.  The  sales- 
man, of  course,  "works"  his  territory  closely,  and  con- 
stantly secures  new  business  by  his  own  methods ;  yet  he 
is  greatly  helped  by  having  such  information  as  the  main 
office  may  secure  with  respect  to  possible  customers. 
Consumers  who  are  not  aware  of  the  existence  of  a  local 
agency,  for  example,  or  who  do  not  know  how  to  reach 
the  local  salesman,  may  "write  in"  for  information. 
Many  inquiries  will  be  received  in  response  to  advertising. 
Salesmen  may  learn,  from  their  customers  or  from  other 
sources,  of  new  business  which  might  be  secured  in  some 
other  salesman's  territory.  A  clearing-house  will  be 
maintained  where  all  such  information  can  be  assembled 
and  sorted  out,  and  sent  as  "leads"  to  tlie  local  managers 
for  distribution  to  the  salesman  who  covers  the  territory 
concerned.  The  sales-manager,  however,  must  not  think 
that  he  does  his  full  duty  when  he  has  supplied  "leads." 


444  PRINCIPLES  OF  BUSINESS 

Each  salesman,  such  is  human  nature,  usually  considers 
his  own  territory  the  worst  in  the  division,  if  not  in  the 
whole  country. 

"Sales  quota." — The  "sales  quota"  is  the  expected 
volume  of  sales  for  a  given  period  in  a  given  territory  or 
other  subdivision  of  the  selling  field.  The  "quota"  for 
a  given  territory  is  decided  upon  after  a  careful  analysis 
of  all  the  ascertainable  conditions  affecting  or  giving  in- 
formative data  concerning  sales.  The  analysis  made  will 
include  analysis  of  records  of  past  sales  in  the  territory, 
showing  rate  of  increase  or  decrease  of  sales;  of  market 
statistics  of  all  kinds;  of  the  probable  results  of  projected 
advertising  campaigns ;  and  of  the  personality  of  the  sales- 
man himself. 

Such  a  study  of  selling  conditions  obviously  serves 
several  useful  purposes.  By  adding  together  the  "quotas" 
of  the  individual  territories  the  total  volume  of  expected 
sales  can  be  found.  Production,  accordingly,  can  be  ad- 
justed to  the  probable  demand.  The  economies  effected 
by  such  an  adjustment  are  so  apparent  that  they  need 
not  be  specified.  Advertising  can  be  made  use  of  more 
intelligently,  particularly  with  respect  to  concentration 
upon  the  subdivisions  of  the  market  where  it  is  most 
needed.  The  weak  spots  in  the  selling  organization  are 
brought  to  light;  when  the  weakness  is  located  it  should 
be  an  easy  matter  to  find  the  cause  and  the  remedy — which 
may  lie  in  ( i )  the  product  itself,  (2)  the  peculiarities 
of  the  local  market,  or  (3)  in  the  personnel  of  the  sell- 
ing organization — probably  in  the  salesman,  but  possibly 
in  the  management  itself.  The  analysis  may  show,  for 
example,  that  a  salesman  is  not  in  territory  which  suits 


SELLING  445 

him  best.  A  salesman  may  fail  utterly  in  New  England 
and  yet  be  very  successful  in  the  Middle  West  or  on  the 
Pacific  Coast. 

It  is  scarcely  necessary  to  emphasize  the  fact  that  a 
sales  organization  is  not  an  accident,  that  it  does  not  grow 
up  of  itself,  haphazard,  but  that  it  is  a  definitely-planned 
mechanism  consisting  of  a  number  of  correlated  parts 
each  with  a  certain  function  to  perform,  and  that  if  per- 
formance of  the  mechanism  as  a  whole  is  not  up  to  the 
standard  (or  expected  output)  the  reason  and  the  remedy 
can  be  found  just  as  positively  as  the  "trouble"  in  a 
badly  running  automobile  motor  can  be  found  and  cor- 
rected by  a  competent  mechanic. 

The  "trouble-shooter"  of  the  sales  organization  might 
well  consider  the  analogy  between  his  own  task  and  that 
of  the  automobile  mechanic ;  for  each  part  or  function  of 
the  motor  may  be  seen,  with  a  moderate  exercise  of  the 
imagination,  to  have  its  counterpart  in  the  mechanism 
for  selling  goods.  The  mechanic  may  find  the  source  of 
the  trouble  in  the  "gas,"  the  carburetor,  the  lubrication, 
the  wiring,  the  spark,  the  timing  of  the  valves  or  of  the 
magneto,  loose  bearings,  worn  pistons  or  accumulation 
of  carbon  in  the  cylinders.  Without  going  too  much  into 
detail,  we  may  point  out  that,  in  the  sales  force,  salary 
corresponds  to  the  "gas,"  courtesy  and  tact  to  lubrica- 
tion, the  stimulus  of  competition  to  the  spark,  and  stale 
ideas  or  obsolete  methods  to  carbon  in  the  cylinder  heads. 
As  to  the  rest,  anyone  interested  may  make  his  own 
analogies,  except  that  we  shall  add  that,  if  the  sales 
force  is  to  be  speeded  up,  it  needs  more  gas,  plenty  of 
lubrication,  and  a  good  hot  spark;  and  that  the  timing 


446  PRINCIPLES  OF  BUSINESS 

must  be  perfect,  and  all  lost  motion  taken  out.  If  it  were 
not  for  the  bringing  of  a  touch  of  levity  iniK)  what  is 
intended  as  a  serious  discourse,  we  should  call  attention 
to  the  fact  that  the  carburetor  is  a  device  for  mixing  hot 
air  with  the  gas.  Encouragement  and  sympathy  are  as 
important  as  commissions. 

The  responsibility  of  the  salesman. — While  the  work 
of  the  salesman  is  planned  for  him  by  the  management, 
much  as  the  task  of  the  workman  in  the  shop  is  laid  out 
by  the  planning  department,  the  workman  in  the  shop  is 
responsible  primarily  for  following  instructions,  while 
the  management  assumes  entire  responsibility  for  the  re- 
sults. The  salesman,  on  the  other  hand,  is  practically 
allowed  to  choose  his  own  methods,  and  is  practically  held 
responsible  only  for  results.  He  is  trained,  of  course,  in 
the  use  of  the  methods  which  have  been  found  most 
effective,  but  the  actual  detail  of  making  a  sale  is  some- 
thing that  cannot  be  determined  in  advance.  Since  the 
salesman  is  held  responsible  for  results,  he  must  be  given 
a  corresponding  amount  of  discretionary  authority,  with- 
in certain  limits,  and  must  feel  that  the  house  will  "back 
him  up." 

Energizing  the  selling  force. — Perhaps  the  strongest 
instinct  that  can  be  appealed  to  and  awakened  among 
those  who  have  work  to  do  is  that  of  competition.  When 
a  lively  spirit  of  competition  enters  into  even  the  dullest 
kind  of  work  it  is  turned  into  play.  It  is  probably  true 
that  rarely,  if  ever,  is  anything  exceptionally  good  ac- 
complished unless  the  doer  is  competing,  either  with 
others  or  with  himself — unless  he  is  trying  to  break  a 
record  of  some  kind,  or  to  set  a  new  one. 


SELLING  44.7 

So  the  salesman  is  given  a  "sales  quota"  to  reach,  with 
no  penalty  attached  for  exceeding  it.  If  the  quota  is 
high,  he  regards  it  as  a  challenge. 

Since  the  "quotas"  of  the  dififerent  territories  are 
equitably  determined  in  view  of  market  conditions  and 
the  ability  of  the  salesman,  it  is  possible  to  institute  sales- 
men's contests,  measured  in  percentage  of  quota.  In 
other  cases,  a  point  contest  may  be  instituted,  each  point 
representing  a  certain  amount  of  sales.  The  differences 
in  the  territories,  or  in  the  ability  or  experience  of  the 
respective  salesmen,  may  be  equalized  by  weighting 
the  points.  The  contest,  for  example,  may  be  for  100 
points,  and  one  contestant  may  be  credited  with  a  point 
for  each  $100  of  sales,  while  another,  with  better  terri- 
tory, may  be  given  a  $200  point.  The  rewards  offered 
may  be  either  honorary  or  pecuniary,  but  should  be  both, 
since  the  underlying  reason  for  the  institution  of  a  con- 
test by  the  management  is  the  making  of  an  extra  profit 
for  the  house.  The  salesmen  who  contribute  to  the  mak- 
ing of  this  profit,  while  they  may  covet  the  honor  of  win- 
ning, cannot  but  feel  that  if  honor  is  all  they  get,  they 
are  not  getting  a  "square  deal."  The  first  contest  may 
succeed  with  no  other  prizes  than  a  ribbon  and  a  name 
in  the  list  of  the  winners,  but  the  second  contest  for  such 
prizes  is  likely  to  develop  less  enthusiasm.  It  is  found 
best,  accordingly,  to  reward  the  winners  of  a  salesman's 
contest  by  giving  them  either  cash  prizes  or  increases  in 
salary,  in  addition  to  whatever  the  honorary  award  may 
be.  One  of  the  most  sensible  methods  of  rewarding  the 
winners  is  to  send  them  as  delegates  to  salesmen's  con- 
ventions, with  expenses  paid.     The  salesman's  success  is 


448  PRINCIPLES  OF  BUSINESS 

widely  advertised,  and  both  he  and  the  house  profit  by 
the  new  outlook  and  new  ideas  the  salesman  gets  from 
the  addresses  he  hears  and  the  other  sales'men  he  meets 
and  talks  to. 

It  has  become  a  practice  of  many  houses  to  arrange  for 
annual  conventions  of  their  own  salesmen.  The  policies 
of  the  house  may  at  such  times  become  more  firmly  crys- 
tallized and  a  common  viewpoint  established  for  the  sales- 
men when  they  are  again  dispersed  to  all  parts  of  the 
country. 

Communications  between  the  house  and  the  sales- 
man.— Consistency  in  the  policy  of  the  house,  in  its  deal- 
ings with  the  public,  and  also  the  personal  efficiency  of 
the  salesman,  are  promoted  as  noted  above,  by  the  con- 
ventions and  meetings  of  various  kinds  where  the  sales- 
men and  managers  come  together.  Very  similar  ends  are 
attained  meanwhile  by  the  printing  and  circulation  of  the 
"house  organ,"  a  periodical  designed  partly  as  an  adver- 
tisement to  the  public,  or  to  dealers,  but  which  serves  also 
as  a  means  of  keeping  the  salesmen  informed  of  whatever 
may  be  of  interest  or  practical  value  in  their  work.  Be- 
sides the  house  organ,  the  salesman  receives  letters — 
either  personal  or  form,  or  both — from  the  office,  con- 
taining greetings  and  words  of  encouragement  from  the 
manager.  The  salesman  is  made  to  feel  that  although 
absent  he  is  not  forgotten.  There  is  no  overestimating 
the  cheering  and  stimulating  effect  such  letters  may  have 
upon  him. 

The  "personality  of  the  house." — A  highly  sensitive 
business  organization  develops  a  personality  of  its  own 
and   comports   itself   consistently   wherever   it   may   be. 


SELLING  449 

Just  as  a  man  gives  evidence  of  his  character  and  breed- 
ing wherever  he  goes,  and  is  not  quiet  in  one  place,  bois- 
terous in  another,  or  clothed  modestly  at  one  time  and 
flashily  dressed  at  another,  so  the  business  house  faces 
the  world  with  a  steadfast  demeanor,  which  is  recognized 
as  characteristic  at  any  time  or  place.  This  policy  or 
nature  of  the  house  is  reflected  in  the  deportment  of  its 
salesmen.  The  representatives  of  an  investment  house 
will  not  be  conspicuous  for  their  waist-coats  and  dia- 
monds, nor  should  we  expect  to  see  a  promoter  of  prize- 
fighting or  horse-racing  garbed  I'ike  a  clergyman. 


CHAPTER    XX 

SELLING 

(Continued) 

DISTRIBUTION 

The  problem  of  distribution. — By  distribution  we 
mean  the  allocation  and  transportation  of  goods  as  be- 
tween producers,  dealers,  and  consumers.  The  problem 
of  distribution,  accordingly,  involves  ( i )  the  means  of 
allocation  and  (2)  the  means  of  transportation  and  de- 
livery (a)  to  intermediate  dealers  and  (b)  to  consumers. 

The  ideal  system  of  distribution  is  the  one  under  which 
the  movement  of  the  goods  is  accomplished  at  the  least 
economic  cost.  Other  things  being  equal,  the  cheapest 
way  is  the  most  direct  way — from  producer  to  consumer, 
without  the  intervention  of  dealers  (or  "middlemen"). 
Other  considerations,  however,  are  often  far  from  equal, 
and  the  much-maligned  middleman  in  many  cases  still 
performs  an  economic  service — in  many  cases,  but  not  in 
all. 

The  course  taken  by  goods  in  their  movement  from 
producer  to  consumer — sometimes  direct,  sometimes  via 
merchant,  jobber  and  retailer,  is  known  as  a  "channel  of 
distribution." 

The  disposal  of  goods. — In  the  early  stages  of  indus- 
try distribution  of  goods  was  made  by  the  producer  direct 
to  the  consufner.     Later,  the  merchant,  the  jobber,  the 

450 


SELLING  451 

wholesaler,  and  the  retailer  intervened  between  these 
principals,  the  asumption  of  their  tasks  being  justifiable, 
from  an  economic  standpoint,  because  of  the  difficulty  of 
communication  between  the  producer  and  the  consumer. 
In  these  most  modern  days,  when  ease  of  communication 
and  facility  of  transportation  are  re-established  (al- 
though the  producer  and  the  consumer  may  be  farther 
apart,  with  respect  to  geographical  considerations,  than 
ever  before),  the  tendency  is  to  return  to  the  original  plan 
of  selling  goods  "direct  to  the  consumer;"  except  that 
the  economy  which  characterizes  a  functional  division  of 
labor  makes  necessary  in  many  cases  a  single  merchandis- 
ing agency,  which  may  be  the  sales  department  of  the 
producer,  or  may  be  an  independent  concern. 

The  following  chart  will  serve  to  indicate  the  man- 
ner of  distribution  under  present-day  conditions,  with 
respect  to  certain  representative  commodities  and  selling 
systems. 

The  "regular"  trade  channels. — What  may  be  called 
the  regular  channels  of  distribution  are  those  which  are 
numbered  (i)  and  (2)  on  the  chart.  Through  these 
channels  move  the  bulk  of  the  so-called  staple  commodi- 
ties, many  of  which  are  unbranded.  When  an  article  is 
branded  and  advertised  the  tendency  is  distinctly  toward 
selling  directly  to  the  retailer,  if  not  directly  to  the  con- 
sumer. 

The  merchant. — The  merchant,  whom  we  have  placed 
next  to  the  producer  in  the  chart,  is  distinguished  from 
the  jobber  in  that  his  business  is  more  regular,  especially 
with  respect  to  his  source  of  supply;  the  jobber,  as  his 
name  suggests,  being  a  dealer  who  specializes  in  "job 


452 


PRINCIPLES  OF  BUSINESS 


lots" — the  whole  output  of  a  given   factory,   or  entire 
stocks  of  goods  which  he  distributes  to  other  dealers. 


Producer 


Merchant 


Jobber 


Retailer 


Consume 


er 


LINES    OF    DISTRIBUTIOrj 

(i)   Groceries.     (2)   Cotton  goods.     (3)   Chain  stores, 
order.     (5)  Automobiles. 


(4)  Mail 


The  merchant,  when  his  purchases  are  regular — that  is, 
when  he  purchases  regularly  from  the  same  producers 
and  resells  to  the  same  dealers  or  consumers — becomes  in 


SELLING  453 

reality,  if  not  in  name,  the  selling  agent  of  the  producer 
and  the  purchasing  agent  of  the  dealer  or  consumer. 

We  see,  for  example,  the  commission  merchant  who 
distributes  to  retailers  and  consumers  the  "produce" 
shipped  to  him  by  truck  farmers,  who  rarely  have  the 
facilities  for  reaching  the  retailer  or  the  consumer  di- 
rectly. The  commission  merchant  will  sell  the  produce 
consigned  to  him,  charging  perhaps  lo  per  cent  commis- 
sion, besides  expenses  (the  bulk  of  which  are  transpor- 
tation charges  and  local  drayage).  Acting  in  this  capac- 
ity, he  is  clearly  an  agent  of  the  producer.  Many  so-called 
commission  merchants,  however,  purchase  produce  out- 
right quite  as  often  as  they  handle  it  on  a  commission 
basis. 

The  merchant,  then,  may  in  many  cases  be  regarded  as 
being  the  agent  of  the  producer,  or  his  business  may  be 
so  closely  identified  with  that  of  the  producer  as  to  be,  in 
name  as  well  as  in  fact,  the  sales  department  of  the  pro- 
ducer's organization.  Sometimes  a  selling  corporation 
is  formed  to  handle  the  output  of  a  company,  under  the 
same  ownership  but  under  separate  or  specialized  man- 
agement. In  some  fields,  as  in  the  dry-goods  line,  com- 
mission houses  take  entire  charge  of  the  producer's  over- 
head, advancing  money  on  sales  made,  guaranteeing  the 
customers'  accounts  and  attending  to  the  collection 
thereof. 

Exclusive  agencies. — An  exclusive  agent  is  an  agent 
of  the  producer  or  prior  distributor,  who  has  the  sole 
right  to  make  sales  of  the  product  in  question  within  a 
specified  territory.  Under  the  exclusive  agenc}'  system 
it  is  customary  for  the  producer  to  appoint  some  well- 


454  PRINCIPLES  .OF  BUSINESS 

known  merchandising  concern  as  its  agent  for  a  district, 
which  may  comprise  a  State  or  a  group  of  States,  local 
agents  then  being  appointed  by  the  State  or  district 
agency.  The  principal  agencies  may  receive  a  commis- 
sion on  sales  ranging  from  fifteen  to  thirty-five  per  cent, 
which  commission  is  shared  by  the  local  agency  which 
makes  the  sale.  Any  sale  made  within  the  district,  even 
by  the  producer  himself,  will  be  credited  to  the  district 
agency,  and  by  the  district  agency  in  turn  to  the  local 
agent  in  whose  territory  the  sale  originated. 

A  large  part  of  the  automobile  business  of  the  country 
is  conducted  under  this  system. 

The  exclusive  agency  usually  pays  half  or  all  of  the 
local  advertising  expense,  while  the  "company"  pays  for 
the  general  or  national  advertising. 

Branch  offices  or  stores. — Instead  of  appointing 
dealers  as  agents,  the  producer  may  establish  distributing 
stations  known  as  branch  offices  or  stores.  The  channel 
of  distribution,  witli  respect  to  handling  and  transporting 
the  goods,  differs  but  little,  if  at  all,  from  that  of  tJie 
agency  system,  but  there  may  be  a  variation  in  the  method 
of  recompensing  the  sales  managers  and  salesmen,  who 
may  be  employed  on  a  salary  basis,  or  may  receive  a  com- 
mission or  bonus  in  addition  to  a  fixed  salary. 

Under  this  system  many  products  can  be  sold  directly 
to  the  consumer — particularly,  bulky  or  expensive  articles, 
such  as  farm  machinery,  tractors,  automobiles,  or  pianos 
— articles  which  are  expensive  enough  to  make  a  single 
sale  somewhat  important,  or  articles  which  require  spe- 
cialized salesmanship  or  service  to  the  user.  For  some 
lines — particularly  "novelties" — house  to  house  canvasv 


SELLING  455 

ers  may  be  employed,  but  this  method  is  less  frequently 
used  by  branch  offices  than  by  special  agents. 

The  general  purpose,  however,  of  branch  offices  of  the 
types  which  we  mean  to  include  in  this  classification,  is 
merely  to  facilitate  the  movement  of  goods  to  the  regular 
retail  dealers,  with  the  exception  of  certain  articles  or 
products  which  for  special  reasons  are  better  sold  directly 
to  the  consumer. 

"Direct"  to  the  retailer. — In  such  businesses  as  that 
of  the  meat  packers  or  biscuit  makers,  whose  continued 
success  depends  upon  care  of  their  products  until  they 
reach  the  consumer's  hands,  it  has  been  found  profitable 
to  establish  warehouses,  with  cold  storage  and  other 
facilities,  where  the  quality  can  be  closely  guarded  and 
sales  made  in  small  quantities  to  retailers  as  needed. 
Armour  &  Company^  Swift  &  Company,  and  the  National 
Biscuit  Company  furnish  familiar  examples  of  direct-to- 
retailer  selling.  Manufacturers  of  non-perishable  goods 
also  have  entered  the  direct-to-retailer  selling  field — one 
will  have,  perhaps,  a  ''complete  line"  of  haberdashery,  so 
that  the  handling  of  his  "family  of  products"  in  a  retail 
store  means  a  sales  of  considerable  importance,  justify- 
ing the  employment  of  traveling  salesmen  to  keep  orders 
filled  and  to  induce  other  stores  to  put  in  the  same  "line." 

Many  jobbers  refuse  to  handle  the  goods  of  factories 
that  sell  to  retailers,  just  as  many  retailers  will  not  handle 
the  goods  of  houses  that  sell  to  the  consumer,  so  that  the 
manufacturer  must  consider  carefully  the  possible  results 
of  closing  against  his  products  the  doors  of  many  mar- 
kets. 

Manufacturers'  retail  stores. — Many  manufacturers, 


456  PRINCIPLES  OF  BUSINESS 

notably  shoe  manufacturers,  have  estabHshed  retail  stores 
in  practically  all  of  the  larger  towns,  with  the  object  of 
saving  the  profit  otherwise  taken  by  intermediate  dealers. 
It  is  doubtful  whether  there  is  any  intrinsic  or  essen- 
tial economy  in  the  retail  store  maintained  by  the  manu- 
facturer, since,  from  the  point  of  view  of  the  public,  it 
does  not  matter  who  pays  the  cost  of  distribution — 
whether  the  retail  store  bears  the  manufacturer's  name  or 
some  other  dealer's  name,  the  manufacturer  being  in  this 
case  a  dealer  in  his  own  products.  There  is,  however, 
almost  invariably  a  practical  economy,  facilitated  by  the 
system,  but  not  inherent  in  it;  for  the  same  economy, 
conceivably,  could  be  effected  without  the  system.  Waiv- 
ing this  technicality,  the  advantages  or  savings  in  actual 
practice  are : 

1.  Elimination  of  local  competition  in  the  same  goods, 
relieving  the  community  of  the  support,  possibly,  of  a 
number  of  dealers. 

2.  Intensive  cultivation  of  the  local  market — an  advan- 
tage to  the  manufacturer,  if  not  to  the  public. 

3.  Increased  efficiency  of  advertising. 

4.  Price  maintenance. 

5.  Close  relations  between  consumer  and  producer,  en- 
abling the  manufacturer  to  foresee  and  prepare  for 
changes  in  demand. 

It  will  be  noted  that  the  manufacturer  who  adopts  this 
method  of  disposing  of  his  products  must  be  prepared  to 
carry  it  out  with  vigor,  since  regular  retailers  are  noto- 
riously jealous  of  any  invasion  of  their  field  by  manufac- 
turer or  wholesaler.  A  failure  of  the  plan  would  entail 
a  loss  of  prestige — one  of  the  greatest  assets  of  a  busi- 


SELLING  457 

ness,  closely  allied  to  good-will.  The  dealers  having  been 
antagonized  and  alienated,  the  manufacturer  would  find 
it  more  or  less  difficult  to  resume  profitable  relations  with 
them,  especially  as  they  would  meanwhile  have  arranged 
for  the  handling  of  competitive  goods. 

The  question  of  whether  to  dispose  of  the  output 
through  branch  stores  or  exclusive  agents,  or  through 
regular  retailers,  will  depend  upon  whether  the  goods  in 
question  are  what  is  known  as  a  "shopping"  or  a  "non- 
shopping"  line. 

Most  toilet  articles,  for  example,  as  well  as  collars  and 
ties,  handkerchiefs  and  other  minor  articles  of  apparel, 
are  not  purchased  until  they  are  needed  for  immediate 
use,  at  which  time,  however,  a  supply  for  the  future  may 
be  purchased.  The  buyer  will  not  go  far  out  of  his  way 
to  secure  any  special  brand,  although  he  may  prefer  one 
brand  to  another.  Such  lines,  then,  should  be  distributed 
as  widely  as  possible,  in  as  many  retail  stores  as  possible. 

On  the  other  hand,  articles  which,  in  the  main,  are 
more  expensive,  and  which  the  purchaser  will  buy  in  ad- 
vance of  his  irhmediate  need — such  as  a  suit  of  clothing, 
or  even  a  pair  of  shoes,  are  handled  best  by  means  of 
branch  stores  or  special  agents.  When  good-will  for 
such  articles  is  secured  it  can  be  retained,  and  the  exclu- 
sive agent  or  dealer  can  afford  to  spend  more  for  adver- 
tising, service  to  the  consumer,  and  any  other  means 
whereby  good-will  may  be  secured  and  retained. 

Chain  stores. — Branch  stores,  referred  to  in  the  sec- 
tion above,  are  each  directly  dependent  upon  a  central, 
or  common,  source  of  supply  and  are  designed  primarily 
as  a  means  of  saving,  to  the  manufacturer  and  to  the 


458  PRINCIPLES  OF  BUSINESS 

public,  the  extra  selling  cost  which  attaches  to  goods  in 
the  hands  of  intermediate  dealers.  Chain  stores,  as  dis- 
tinguished from  branch  stores,  are  relatively  Independent 
units  under  one  management,  designed  to  facilitate  econ- 
omy in  merchandising  through  the  savings  which  can  be 
made  by  standardization  of  methods  and  in  buying  goods 
in  large  quantities,  often  from  local  sources  of  supply. 

Chain  stores  dealing  in  groceries  or  other  food  prod- 
ucts— goods  which  are  more  or  less  bulky  and  in  some 
cases  perishable,  and  which  are,  moreover,  to  be  selected 
with  a  view  to  satisfying  a  demand  which  is  largely 
governed  by  local  customs  or  prejudices,  are  most  likely 
to  be  confined  in  their  territorial  scope  to  a  single  city  Or 
locality.  For  a  chain  store  or  any  other  store  to  attain 
the  completest  success  it  is  necessary  that  it  secure  a  large 
and  fairly  constant  patronage.  It  cannot  do  this  unless 
it  is  able  to  supply  not  only  the  principal  needs,  but  also 
the  minuter  needs  of  its  customers,  with  respect  to  the 
goods  which  such  a  store  may  be  expected  to  have  in 
stock.  The  customer  prefers,  so  far  as  possible,  to  buy 
all  his  groceries,  for  example,  at  one  place,  and  if  he  must 
go  from  the  chain  store,  at  which  he  buys  staples,  for 
instance,  at  a  low  price,  to  another  store  to  supplement 
his  purchases  and  satisfy  his  minuter  needs,  his  good- 
will is  not  secured.  He  may  prefer  to  pay  a  slightly 
higher  price  elsewhere,  in  order  to  save  himself  the 
trouble  of  going  to  more  than  one  place.  An  intensive 
study  of  the  market,  accordingly,  is  necessary,  which 
means  an  intensive  study  of  the  buying  habits  of  each 
community;  and  the  chain  of  stores  may  be  extended 
with  safety  only  to  those  sections  of  the  market  of  which 


SELLING  459 

such  an  intensive  study  is  practicable.  These  considera- 
tions, as  we  have  observed,  apply  with  particular  force 
to  stores  which  deal  in  perishable  or  bulky  products,  for 
if  these  are  not  disposed  of  they  are  either  lost  outright 
or  transferred  to  another  sales  station  at  a  considerable 
expense. 

The  restriction  of  stores  of  this  class  to  certain  locali- 
ties is  furthered  also  by  the  fact  that  in  a  single  large 
city  and  its  environs  communication  between  the  several 
stores  in  the  chain  is  far  easier  than  it  is  where  they  are 
widely  dispersed.  The  manager  can  keep  in  constant 
touch  with  each  unft,  by  having  a  telephone  on  his  desk 
and  a  motor  at  the  curb.  The  allocation  of  stock  is  also 
a  simple  matter,  since  a  motor-truck  can  deliver  supplies 
from  a  central  warehouse  wherever  and  whenever  they 
are  needed,  or  can  adjust  the  holdings  of  the  different 
stores  by  moving  goods  from  one  to  another.  Where  it 
is  possible  thus  to  equalize  the  stocks  in  the  various  stores 
in  the  chain,  the  investment  may  be  greatly  reduced. 

It  may  be  noted  also  that  the  good-will  of  the  customer 
is  held  not  only  by  the  individual  store  in  the  chain,  but 
by  any  store  bearing  the  name.  When  a  customer 
"moves,"  he  is  far  less  likely  to  leave  the  city  than  he  is 
to  take  up  his  abode  in  another  section  of  the  same  city. 
Finding  near-by  a  store  with  the  familiar  name  and  the 
same  appearance,  he  transfers  to  it  his  patronage  and  his 
good-will.  It  is  in  recognition  of  this  trait  of  human 
nature  that  all  the  stores  of  one  chain  are  painted  red, 
of  another  green,  and  of  another,  yellow.  The  customer 
in  a  strange  locality  feels  a  definite  pleasure  of  recognition 
upon  seeing  the  well-known  name  and  color.     Uncon- 


46o  PRINCIPLES  OF  BUSINESS 

scious  obedience  to  "force  of  habit"  is  also  a  factor  to  be 
considered/ 

The  considerations  which  are  effective  in  restricting 
the  scope  of  chain  stores  which  deal  in  perishable  prod- 
ucts apply  with  much  less  force  to  those  handling  goods 
which  are  not  perishable  and  which  meet  less  specialized 
needs.  In  this  class,  the  most  familiar  examples  are  the 
five-and-ten-cent  stores,  the  United  Drug  stores  and  the 
United  Cigar  stores. 

Location  of  chain  stores. — Undoubtedly  one  of  the 
things  which  has  helped  to  make  chain  stores  successful 
is  their  location,  in  each  instance,  ^t  a  strategic  point. 
There  is,  of  course,  no  reason  why  strategy  of  location 
should  be  a  peculiarity  of  the  chain  store,  but  it  seems 
that  the  advantages  of  location  have  been  more  keenly 
realized  by  chain  store  managers  than  by  most  others. 
This  is  explainable,  in  part,  by  the  fact  that  the  chain 
store  manager  has  learned  by  experience  the  requirements 
of  a  good  location,  and  has  learned  the  methods  by  which 
the  best  location  may  be  ascertained.  Among  the  things 
that  must  be  known,  when  a  given  site  is  under  considera- 
tion, are :  the  number  of  people  who  pass  each  day — men, 
women  and  children;  where  they  are  going;  their  occupa- 
tions ;  and  their  purchasing  habits  or  requirements.     The 

^  Incidentally,  we  observe  that  the  instinct  by  which  we  turn  almost 
unconsciously  into  familiar  places  is  the  psychological  explanation 
of  the  general  similarity  in  appearance  between  whoily  unrelated 
(as  to  ownership)  places  of  business,  such  as  ice-cream  parlors, 
barber  shops,  "lunch"  rooms  or  boot-black  stands.  Each  individual 
enterprise  profits  by  obtaining  a  share  of  the  increased  patronage 
which  the  group  as  a  whole  receives  as  a  result  of  this  appeal  to 
habit.  "The  store  that's  difTorent"  is  a  "slogan"  which  usually 
makes  a  very  poor  psychological  appeal.  The  "difference"  is 
something  which  should  be  kept  under  cover,  attention  being 
directed  specifically  to  whatever  particular  advantages  are  offered. 


SELLING  461 

numbers  can  be  found  out  almost  with  exactness;  the 
other  questions  can  be  answered  only  with  a  partial  or 
approximate  accuracy. 

It  is  true  also  that  the  superior  financial  position  of  the 
chain  store  organization  as  compared  with  that  of  the 
average  small  retailer  enables  the  manager  to  secure  a 
site  which  requires  an  immediate  outlay  beyond  the 
capacity  of  the  individual,  even  were  he  aware  of  its  de- 
sirability. 

Standardization  of  methods,  equipment  and  stock. 
— It  is  quite  obvious  that  chain  stores  have  a  unique  ad- 
vantage over  a  corresponding  number  of  unrelated  estab- 
lishments, in  that  the  system  makes  possible  a  standard- 
ization of  equipment  and  stock  which  permits  purchasing 
in  large  quantities,  with  a  minimum  of  reserve  to  be  kept 
on  hand.  Since  the  goods,  including  their  packages,  are 
standardized,  it  is  a  comparatively  simple  matter  to  work 
out  the  most  efficient  methods  of  handling  the  goods,  and 
to  apply  these  methods  in  each  individual  store.  Con- 
sequently, there  is  economy  not  only  in  the  doing  of  the 
routine  work  but  also  in  the  training  of  new  employees, 
who  I'nay  be  taught  the  routine  methods  with  a  minimum 
of  supervision  by  a  high-salaried  manager. 

Growth  of  the  chain  store  movement. — An  indica- 
tion of  the  strength  of  the  chain-store  plan  in  modern 
retailing  is  seen  in  the  recent  organization  in  New  York 
City  of  the  Chain  Store  Grocers'  Association,  the  mem- 
bership including  the  managers  of  eighteen  chains,  repre- 
senting a  total  of  five  thousand  retail  stores.  In  another 
field — that  of  the  drug  business — the  gross  sales  of  the 
United  Drug  Stores  in  191 7  were  over  $40,000,000;  of 


462  PRINCIPLES  OF  BUSINESS 

which  $22,000,000  was  the  actual  quota  of  the  Liggett 
group,  comprising  175  stores. 

Obviously,  such  statistics  as  these  are  not  encouraging, 
to  say  the  least,  to  the  independent  retailer.  The  whole- 
saler, too,  is  menaced  by  the  growth  of  the  chain-store 
system,  for  the  chain  store  is  often  in  a  position  to  ab- 
sorb the  entire  output  of  a  manufacturer  or  other  pro- 
ducer, leaving  the  wholesaler  with  nothing  to  do. 

The  following  notice,  a  bulletin  of  the  Montana  Whole- 
sale Grocers'  Association,  sent  recently  to  its  members, 
illustrates  the  attitude  of  the  dealers  in  control  of  the 
"regular"  trade  channels  toward  interlopers — chain 
stores  and  other  anti-middleman  systems. 

"The  Wholesale  Grocers  have  done  much  to  co-operate  with  the 
Government,  and  the  attitude  of  the  Government  has  been  to  con- 
firm the  jobber  as  the  logical  distributor  of  food. 

"The  manufacturers  are  coming  more  and  more  to  recognize  this 
truth. 

"The  American  Sugar  Refining  Company  has  again  changed  its 
policy,  and  is  now  marketing  its  products  through  the  wholesale 
grocer. 

"Now  is  the  time  for  us  to  work  hand  in  hand  with  both  the 
manufacturers  and  the  retailers  for  two  reasons. 

"On  one  side,  we  have  the  packers  coming  into  the  field  to  take 
the  place  of  the  jobber. 

"On  the  other  hand,  we  have  the  chain  stores  that  will  continue 
to  grow  unless  checked  by  the  retailers,  and  the  individual  retailer 
cannot  do  it  unless  the  wholesale  grocer  is  willing  to  co-operate 
with   them   in   every   possible   way. 

"The  jobber  should  put  forth  every  effort  to  support,  encourage 
and  build  up  the  retailer  who  is  willing  and  shows  a  disposition 
to  co-operate  with  him. 

"The  jobber  must  seize  each  opportunity  to  render  every  service 
possible  to  the  manufacturer  and  the  retailer." 

Co-operation  between  dealers,  however,  unless  it  has  as 
its  object  the  lowering  of  costs  or  the  betterment  of  serv- 
ice to  the  consumer,  is  of  very  doubtful  value.  With  re- 
spect to  its  ethics,  such  a  co-operation  is  questionable,  and 
the  practicality  of  obtaining  more  than  the  merest  tempo- 


SELLING  463 

rary  benefit  is  even  more  so.  We  must,  nevertheless, 
credit  the  regular  wholesaler  and  the  regular  retailer,  in 
their  antagonism  toward  chain  stores  and  mail-order 
houses,  with  a  sincerity  of  purpose;  each  undoubtedly 
feels  that  his  way  of  serving  the  community  is  the  best 
one.     Which  is  right,  is  for  the  public  to  decide. 

The  mail-order  house. — The  mail-order  business,  as 
is  well  known,  is  of  comparatively  recent  origin,  and  has 
received  a  great  stimulus  through  the  establishment  of 
the  parcel  post. 

The  mail-order  house  represents  the  extreme  develop- 
ment of  the  present  tendency  to  sell  directly  to  the  con- 
sumer— especially  if  it  manufactures  or  produces  its  own 
goods.  Many  factories  market  their  goods  exclusively 
by  the  mail-order  system;  other  concerns,  of  the  depart- 
ment-store type,  buy  most  of  their  stock,  but  manufac- 
ture certain  articles  themselves.  Other  articles  are 
made  to  its  order,  and  bear  a  distinctive  trade  name — 
rarely,  however,  one  that  identifies  the  article  with  its 
origin.  In  fact,  a  most  interesting  situation  is  to  be  ob- 
served with  respect  to  the  names  borne  by  mail-order 
articles,  indicating,  as  they  do,  a  number  of  compromises. 
The  situation  may  be  outlined  as  follo>vs : 

1.  The  mail-order  house  must  handle  all  grades  of 
goods,  and  must  justify  itself  by  offering  even  its  highest 
grades  at  less  than  the  regular  price. 

2.  The  manufacturer  of  a  standard  article,  although  he 
may  be  glad  of  the  chance  to  sell  to  the  mail-order  house 
in  large  quantities  at  a  lower-than-usual  price,  can  not 
afford  to  spoil  the  market  for  his  branded  articles  by 
allowing  them  to  be  identified  as  having  been  purchased 


464  PRINCIPLES  OF  BUSINESS 

through  a  mail-order  house  at  a  cut  price.  He  is  obliged, 
therefore,  to  refuse  the  use  of  his  regular  trade-mark, 
and  also  to  make  such  changes  in  the  form  or  appearance 
of  his  product  as  will  prevent  it  from  being  identified  with 
his  regular  output. 

3.  The  consumer,  also,  desires  to  conceal  the  fact  that 
he  deals  with  a  mail-order  house,  especially  if  he  lives  in 
a  small  town.  So  many  things  have  been  said  about 
mail-order  houses,  by  his  friends  among  the  retailers,  that 
he  cannot  buy  from  them  without  a  sense  of  guilt  and 
without  incurring  the  danger  of  retaliation  on  the  part 
of  the  local  dealers.  His  conscience  in  this  case,  as 
Freud   would   explain   it,   is   a   "social   fear." 

The  result  is  that  the  mail-order  house  must  choose 
a  new  and  often  apparently  meaningless  name  to  be  used 
as  a  trade-name  for  the  article  in  question — something 
like  "Seroco,"  for  example,  which  can  be  interpreted 
only  by  the  initiated. 

Advantages  of  mail-order  selling. — Among  the  prin- 
cipal economic  advantages  of  the  large  mail-order  house 
are  the  following: 

1.  Goods  may  be  purchased  in  large  quantities. 

2.  A  complete  stock  may  be  kept,  with  respect  to 
classes  of  goods  and  grades  within  the  classes. 

3.  An  expensive  location,  as  in  the  center  of  a  shopping 
district,  is  not  necessary. 

4.  Goods  may  be  selected  by  the  consumer  at  his 
leisure,  from  a  perusal  of  the  catalogue. 

5.  The  work  of  the  day  or  of  the  week  is  regularized; 
there  are  no  "rush"  hours;  the  employees  may  be  kept 
busy  during  their  entire  working  periods. 


SELLING  465 

6.  Because  of  the  possibility  of  forecasting  demand, 
since  the  customers  of  the  house  are  widely  scattered  and 
are  as  a  whole,  much  less  affected  by  changing  conditions 
than  are  groups  in  a  single  district,  the  necessary  quan- 
tities of  each  article  or  product  can  be  kept  in  stock,  with 
a  comparatively  small  reserve.  Consequently,  the  latest 
or  freshest  goods,  most  satisfactory  to  the  consumer,  can 
be  supplied,  and  the  investment  in  stock  is  at  the  same 
time  kept  at  a  minimum. 

Disadvantages  of  the  mail-order  system. — Despite 
the  many  economies  inherent  in  the  mail-order  system  of 
selling,  the  profits,  as  a  rule,  are  not  large  in  proportion 
to  the  investment  required.  This  is  largely  because  of 
the  enormous  advertising  expense,  which  causes  the  aver- 
age selling  cost  to  run  close  to  20  per  cent  of  the  gross 
sales. 

The  antagonism  of  local  dealers  and  the  distrust  of  the 
public  are  also  to  be  considered,  although  these  are  not 
to  be  looked  upon  as  being  disadvantages  inherent  in  the 
system. 

There  is  an  economic  waste  in  the  shipping  of  goods  in 
small  quantities  to  points  at  a  distance.  This  is  partly 
overcome  by  the  establishing  of  district  warehouses 
throughout  the  country,  from  which  the  more  bulky  goods 
are  shipped  to  the  consumer. 

Mail-order  sales  methods. — The  larger  mail-order 
houses  of  the  department-store  type  employ  no  salesmen 
and  do  little  if  any  newspaper  or  magazine  advertising, 
but  do  their  selling  almost  exclusively  through  their  large 
illustrated  catalogues,  supplemented  by  circulars  and 
price-lists  of  special  classes  of  commodities,  and  followed 


466  PRINCIPLES  OF  BUSINESS 

by  numerous  form  and  personal  letters.  The  mait-order 
house  is  never  too  busy  to  write  a  letter. 

An  illustration  of  the  cumulative  effect  of  the  follow- 
up  letter  is  seen  in  the  case  of  a  young  negro  in  Texas, 
who  had  purchased  a  typewriter  from  a  mail-order  house 
— a  not  very  practical  machine,  costing  $3.75,  with  the 
alphabet  on  the  rim  of  a  rotary  disc. 

"What  is  that  you  have  there,  Richard?"  he  was  asked. 

"Dat's  what  dey  calls  er  typewriter,"  he  replied. 

*'What  need  have  you  for  a  typewriter?" 

"Well,  I  kin  write  a  letter  wid  it  in  a  day,  an'  I  don't 
have  nothin'  else  to  do  Sundays." 

"But  how  did  you  ever  happen  to  think  of  buying  such 
a  thing  in  the  first  place?" 

"Well,  suh,  hit  was  jes'  like  dis.  Mister  Montgomery 
Ward  and  Company,  dey  knowed  I  had  done  sent  fo'  one 
o'  dey  catalogues  and  never  had  bought  nothin'  f  um  em 
yit,  so  dey  written  me  a  letter  'bout  it;  an'  after  so  long 
er  time  dey  written  another  letter,  an'  dey  kep'  a  writin', 
an'  kep'  a  writin',  till  I  finally  made  up  ma  mind  ef  F 
didn't  buy  nothin'  f'um  em  dey  might  think  I  wasn't  no 
business  man." 

The  large  mail-order  house  is  more  at  the  mercy  of  the 
public,  perhaps,  than  is  almost  any  other  form  of  business 
enterprise.  Having  no  salesmen,  no  advocates  except  its 
own  satisfied  customers,  and  doing  no  general  advertising 
with  a  view  to  influencing  public  opinion,  its  only  hope 
of  continued  success  lies  in  gaining  and  keeping  the  good- 
will of  the  public,  by  giving  satisfactory  goods  at  low 
prices  and  by  correcting  faithfully  each  and  every  cause 
of  complaint      A  single  established  case  of  unfair  dealing 


SELLING  467 

would  be  seized  upon  avidly  by  its  enemies  and  advertised 
far  and  wide.  Honesty  is  not  only  the  best  policy  for  the 
mail-order  house ;  it  is  the  only  policy. 

Mail-order  departments  of  retail  stores. — It  might 
seem  at  first  thought  that  the  addition  of  a  mail-order  de- 
partment to  a  store  which  had  an  established  over-the- 
counter  trade  should  be  exceedingly  profitable,  the  extra 
sales  resulting  representing  almost  clear  gain.  This, 
however,  does  not  prove  to  be  the  case,  although,  of 
course,  many  retail  stores  actually  do  an  immense  mail- 
order business.  Where  such  course  is  decided  upon,  one 
or  the  other  of  two  things  must  be  done.  Either  (i)  a 
separate  stock  must  be  kept  from  which  mail  orders  are 
to  be  filled,  or  (2)  orders  must  be  filled  from  the  same 
stock,  necessitating  practically  the  same  procedure  in 
filling  each  order  as  is  followed  in  ordinary  purchases  by 
a  customer.  The  expense  incurred,  accordingly,  includes 
the  cost  of  the  employees'  time  (''shoppers"  and  sales- 
clerks)  ;  the  extra  handling  of  the  goods,  since  disposing 
articles  for  retail  sale  is  something  that  requires  not  a 
little  care;  and  the  extra  bookkeeping  or  accounting  costs. 
Added  to  these  must  be  the  share  of  the  burden  of  fixed 
charges  on  the  store  and  equipment,  which  charges  are 
necessarily  high,  since  the  retail  store  must  be  located  in 
a  favored  shopping  district. 

If  a  separate  stock  is  carried,  it  would  seem  to  be  ex- 
pedient to  conduct  the  mail-order  department  as  a  sepa- 
rate business,  in  a  less  expensive  and  more  advantageous 
location. 

Mail-order  competition. — The  invasion  of  the  local 
selling  fields  by  the  mail-order  houses  and  chain  stores  is 


468  PRINCIPLES  OF  BUSINESS 

keenly  resented  by  the  local  retailers,  especially  in  small 
communities,  where  personal  as  well  as  business  rela- 
tions often  exist  between  the  dealer  and  his  customers. 
The  local  merchant  feels  that  he  is  rendering  an  indis- 
pensable service  and  that  he  is  therefore  entitled  to  the 
full  support  of  the  community.  Not  only  does  he  keep 
a  supply  of  goods  which  his  customers  must  have,  but 
he  may,  in  rural  districts,  purchase  their  farm  and  dairy 
products,  and  may  grant  them  liberal  terms  of  credit, 
"carrying"  them  until  their  crops  are  sold.  When  he 
sees  his  customers  taken  away  by  the  catalogue  house — 
continuing  to  buy  from  him  the  articles  upon  which  there 
is  the  least  profit,  but  sending  to  Chicago  for  the  rest  of 
their  supplies — he  cannot  help  feeling  aggrieved.  It  ij 
not  to  be  wandered  at  that  the  merchant  will  sometimes 
resort  to  somewhat  unethical  retaliatory  measures,  tend- 
ing to  discredit  the  mail-order  house  and  its  goods. 
Throughout  the  South,  for  example,  it  is  commonly  sus- 
pected that  Montgomery  Ward  is  a  negro,  Sears  Roebuck 
a  negro,  and  Kress  a  negro,  intimations  to  this  effect  be- 
ing circulated  judiciously  by  local  retailers. 

Since  the  mail-order  houses  and  chain  stores  can  offer 
certain  advantages  in  price  and  convenience  which  can- 
not be  duplicated  by  the  local  retailer,  it  is  futile  for  him 
to  fight  them  with  their  own  weapons.  He  luust  oppose 
them  by  finding  new  ways  of  giving  individual  service  to 
his  customers,  and  by  making  that  service  more  desirable 
than  the  service  of  the  catalogue  house,  even  when  the 
difference  in  price  is  taken  account  of. 

Further  than  this,  as  Paul  E.  Derrick  points  out,^  he 

1  How  to  Reduce  Selling  Costs.    Geo.  Newnes,  Ltd.,  London,  191 7. 


SELLING  469 

may  take  hope  from  the  fact  that  as  the  big  dealers  grow 
larger  they  feel  the  competition  of  each  other  and  must 
advertise  so  extensively  or  adopt  such  other  means  of 
self-preservation  as  to  increase  their  own  selling  costs  to 
a  point  where  they  may  lose  much  of  the  advantage  over 
the  small  dealer  which  they  had  previously  possessed. 

The  delivery  problem, — In  the  distribution  of  goods 
there  are  few  problems  of  greater  interest  than  that  of 
how  to  transport  the  goods  from  the  point  of  production 
to  the  consumer,  and  especially  of  how  to  make  delivery 
of  the  goods  as  between  the  retailer  and  the  consumer. 

The  great  waste  involved  in  the  present  systems  of 
retail  distribution  is  in  the  duplication  of  service  which 
is  almost  invariably  found.  The  delivery  wagons  of 
many  dealers  pass  each  morning  or  evening  over  the  same 
routes,  or  at  an}-  rate  over  the  same  streets,  stopping  at 
the  same  houses,  each  leaving  a  package  from  the  dry- 
goods  store,  a  box  of  groceries,  a  bottle  of  milk,  or  a 
bundle  of  laundry.  It  would  not  be  so  distressing  if  only 
it  could  be  arranged  that  one  grocer's  wagon,  and  one 
milkman's  wagon,  for  example,  should  deliver  all  the 
groceries  and  all  the  milk  to  a  certain  street;  but  we  see 
numerous  wagons  on  the  same  street,  stopping  even  at 
the  same  houses,  carrying  identical  kinds  of  commodities, 

A  saving  is  effected  when  shoppers  carry  home  their 
own  packages  and  regularize  or  consolidate  their  pur- 
chases in  order  to  save  extra  delivery  trips.  The  funda- 
mental remedy,  however,  seems  to  lie  in  the  development 
of  delivery  systems  comparable  to  the  street  railway 
transportation  systems,  whereby  the  city  will  be  divided 
into  delivery  zones  or  districts  with  regular  service,  once 


470  PRINCIPLES  OF  BUSINESS 

or  twice  daily,  given  by  a  single  transportation  concern. 
Some  progress  has  already  been  made  in  this  direction, 
but  the  idea  has  scarcely  as  yet  even  reached  the  experi- 
mental stage.  It  seems  clear,  however,  that  some  such 
community  delivery  service,  at  least  for  similar  classes  of 
goods,  must  eventually  be  worked  out. 

"Door  delivery," — A  movement  is  also  on  foot  for 
the  establishing  of  a  system  of  "door  delivery"  for  goods 
shipped  by  freight.  The  wastefulness  of  the  present 
method  will  at  once  be  apparent  to  anyone  who  considers 
the  fact  that  each  consignee  must  send  a  conveyance  of 
some  kind,  perhaps  from  miles  away,  to  fetch  even  a 
small  package  from  the  freight  warehouse.  If  the  trans- 
portation charges  were  made  to  include  those  of  door 
delivery,  the  transporting  railroad  or  other  company 
would  maintain  motor  trucks  which  would  make  these 
deliveries,  each  truck  carrying  a  full  load  and  going  to 
many  consignees,  probably,  in  the  course  of  a  single  trip. 

"Highway  freight." — With  the  development  of  the 
motor  truck  and  the  building  of  good  roads,  it  is  possible 
in  many  cases  to  reduce  delivery  costs  by  making  ship- 
ment via  "highway  freight."  Goods  carried  on  a  motor 
truck  can  frequently  be  sent  immediately  to  their  destina- 
tion, with  a  considerable  saving  in  the  cost  of  rehandling. 
Thus  on  short  hauls  the  motor  truck  will  easily  justify 
itself.  The  result  of  this  new  method  of  transportation 
will  probably  not  injure  the  railroads.  Motor  trucks  will 
not  be  in  competition  with  the  railroads  except  in  special 
instances,  but  their  peculiar  function  will  generally  be  to 
supplement  the  railroads  as  feeders  and  to  relieve  the  rail- 
roads of  unprofitable  short-haul  business.     Probably  an- 


SELLING  471 

other  function  will  be  the  specialized  handling  of  goods, 
like  fish  and  other  food  products  needing  quick  delivery 
to  markets.^ 

Reducing  distribution  costs. — It  would  seem  improb- 
able that  the  public  will  endure  much  longer  the  economic 
waste  which  results  from  the  present  haphazard  methods 
of  distribution.  The  excessive  cost  of  distribution  which 
is  closely  allied  with,  or  is  rather  a  component  of,  the  high 
cost  of  selling,  can  be  remedied,  it  would  seem,  only  by 
very  radical  changes  in  the  industrial  organization. 

The  evils  upon  which  attention  must  be  concentrated 
are:  futile  expenditure  of  effort,  and  duplication  of 
effort.  By  the  first  we  mean,  effort  that  is  expended  in 
the  attempted  sale  and  distribution  of  something  which 
the  public  does  not  want  or  need,  or  which  it  is  already 
supplied  with ;  by  the  second  we  mean,  the  employment  of 
many  separate  delivery  systems  where  fewer  would  suf- 
fice, if  operated  under  a  single  management. 


BIBLIOGRAPHY 

Barrett,  H.  J.,  Hoiv  to  Sell  More  Goods. 

Briscoe,   N.  A.,   Fuoidamentah  of  Salesmanship. 

Derrick,   Paul   E.,   Hoiv   to   Reduce   Selling   Costs. 

Fisk,  J.  W.,  Retail  Selling. 

Hoover,   S.  R.,   The  Seience  and  Art  of  Salesmanship. 

Maxwell,  W.  M.,  Salesmanship. 

Nystrom,  Paul  H.,  Retail  Selling  and  Store  Management, 

Opdycke,  J.  B.,   Adzrrtising   and  Selling   Practice. 

Rittenberg,  Max.  Modern  Retailing. 

Scott,  Walter   Dill,   Influencing  Men  in  Business. 

Whitehead,    Harold,    Principles   of  Salesmanship. 

Derrick,  Paul  E.,  Hozv  to  Reduce  Selling  Costs. 

Maxwell,  W.   M.,   The   Training   of  a  Salesman. 

Ivey,  Paul  W.,  Elements  of  Retail  Salesmanship. 

*  See  System,  November,  1919. 


CHAPTER    XXI 

ADVERTISING 

Psychological  principles  of  effective  advertising. — 

The  growth  of  advertising  is  one  of  the  marvels  of  our 
new  industrial  civilization.  It  is,  on  the  one  liand,  a  re- 
sult of  competition  in  the  markets,  due  itself  to  the  con- 
stant doubling  and  redoubling  of  output  from  the  manu- 
factories and  to  the  ready  means  of  transportation,  which 
has  kept  pace  with  that  increasing  output.  It  is,  on  the 
other  hand,  a  cause  acting  upon  the  consumer,  ever  creat- 
ing a  fresh  demand  for  commodities,  and  thus  reacting 
upon  the  manufactories  and  serving  to  increase  their  out- 
put. Production  and  advertising  act,  react,  and  interact 
upon  each  other  in  so  complex  a  manner  that  their  exact 
relations  can  hardly  be  determined.  We  find  here  a  con- 
crete example  of  the  formula:  (a)  Owls  lay  eggs,  (b) 
Eggs  hatch  into  owls. 

An  advertisement  is  merely  a  notification  to  the  public 
of  the  name,  uses,  merits,  or  price  of  certain  goods 
offered  for  sale — ^publicity  is  its  only  absolute  essential. 
Advertising  is  the  business  of  making  such  advertise- 
ments. The  card  on  the  opposite  page  comes  within  the 
range  of  the  definition  of  an  advertisement. 

Now  this  is  about  as  bad  an  advertisement  as  it  is  pos- 
sible to  construct.  Messrs.  James  Peters  &  Son  will 
hardly  increase  their  sales  by  so  much  as  a  single  hat  or  a 

single  box  of  corn  salve  as  a  direct  or  indirect  result  of 

472 


ADVERTISING  473 

such  a  notice.  Contrast  with  it  almost  any  magazine 
advertisement  of  the  Quaker  Oats  Company  and  you  will 
see  the  difference  between  an  advertisement  and  a  good 
advertisement.     The  sole  aim  of  an  advertisement  is  to 


JAMES  PETERS  AND  SON 

Dealers   in   general   merchandise,   hats,   shoes, 

notions,  staple  and  fancy  groceries,  patent  medicines, 

oils,    paints,    varnishes,    window    glass,    and    everything 

for  the  household 

West  Side  of  Square  Racoon  Creek,  Arkansas 


enable  the  seller  to  dispose  of  his  goods  at  a  profit — if  it 
does  not  contribute  to  that  end  it  merely  represents 
wasted  time  and  money.  Successful  advertising  is  as 
much  a  science  and  art  as  any  other  profession,  and  the 
principles  may  be  learned  and  applied  in  much  the  same 
way  as  those  of  any  other  business — that  is,  by  assiduous 
study  and  painstaking  practice. 

Properly  understood,  advertising  is  a  special  phase  of 
salesmanship,  being,  in  fact,  an  extension  of  the  sales- 
man's opportunity  of  selling  goods  to  an  individual  buyer 
with  whom  he  comes  in  personal  contact  to  the  broader 
privilege  of  convincing  whole  masses  of  consumers  to  buy 
the  particular  commodity  which  he  has  to  offer.  In  gen- 
eral, therefore,  the  methods  of  appeal  discussed  in  the 
chapter  on  selling  will  hold  good  in  the  business  of  adver- 


474  PRINCIPLES  OF  BUSINESS 

tising,  but  the  new  factors  entering  into  the  problem, 
due  to  the  separation  in  time  and  place  of  seller  and  buyer, 
demand  careful  investigation  and  discussion,  in  order  that 
the  proper  readjustment  of  emphasis  may  be  made. 

As  in  general  salesmanship  a  ready  familiarity  with 
human  nature  is  of  first  importance,  so  in  advertising  an 
accurate  knowledge  of  the  laws  governing  human 
thought,  feelings,  and  activities  must  be  so  well  under- 
stood that  they  can  be  applied  unconsciously.  Psychol- 
ogy is  the  basis  of  the  whole  structure  in  either  case,  but 
there  are  many  paths  of  divergence.  In  individual  or 
personal  salesmanship,  for  instance,  each  customer  is  a 
separate  and  distinct  problem  to  be  solved  by  the  personal 
equation  method,  whereas  in  advertising  the  individuals 
will  be  found  massed  into  thousands  and  hundreds  of 
thousands,  and  cannot  be  reached  except  by  methods  of 
universal  appeal.  The  attack  against  these  masses  must 
be  made  at  their  most  vulnerable  points  by  a  challenge 
to  self-interest,  self-love,  desire  for  ease,  imagination, 
self-respect,  or  to  whatever  other  human  feelings  can 
most  easily  be  touched.  Thus  the  advertiser  becomes  a 
specialist  in  his  own  somewhat  narrow  field  of  applied 
psychology.  He  must  know  what  motives  are  most 
readily  appealed  to  in  the  class  of  people  to  whom  in  each 
advertisement  he  may  be  addressing  himself,  and  he  must 
»know,  furthermore,  how  to  make  that  appeal  effective. 
His  methods  of  offering  for  sale  a  stock  of  damaged  shoes 
and  a  late-model  car,  price  $5,000,  would  be  quite  differ- 
ent. In  one  case  price  would  be  his  key-note,  whilst  in 
the  other  he  would  attempt  to  create  an  atmosphere  of 
quiet  elegance  suggestive  of  wealth  and  exclusiveness. 


ADVERTISING  475 

Under  modern  business  conditions  buyers  are  not  in 
the  habit  of  running  over  one  another  to  make  their  pur- 
chases, even  when  they  know  their  own  desires,  which 
they  seldom  do.  The  benevolent  hand  of  that  great 
economic  missionary,  the  advertising  man,  must  usually 
point  them  to  what  they  want  and  show  them  just  where 
and  how  to  find  it.  It  is  true  that  the  consumers  know 
beforehand  that  they  must  have  food  to  eat  and  clothing 
to  wear,  but  they  do  not  know  just  what  food  and  just 
what  clothing.  Though  they  are  not  often  aware  of  it 
themselves,  they  are  waiting  for  some  one  to  overcome 
their  inertia  by  a  suggestion. 

Now  the  advertiser's  task  would  be  an  easy  one  if  he 
had  merely  to  say:  "Buy  Z  collars."  In  this  wide-awake 
age  of  ours  a  score  of  other  advertisers  will  be  saying 
the  same  thing  about  9.  score  of  other  makes  of  collars, 
and  saying  it  more  effectively.  One  will  attract  attention 
by  illustrations  of  distinguished-looking  gentlemen  and 
society  chaps  who  know  what  is  what,  all  wearing  Y 
collars  and  looking  the  very  embodiment  of  easy  grace 
or  urban  magnificence.  A  second  will  carry  his  mission- 
ary work  a  step  further — in  appeal  to  certain  classes — 
and  close  with  a  sly  suggestion  like  "Costs  no  more !" 

Like  most  fundamentals,  the  basic  psychological  prin- 
ciples of  the  art  are  simple  enough  to  be  comprehended 
after  a  clear  statement;  the  difficulties  will  be  encountered 
later  with  the  endeavor  to  apply  the  abstract  principles  to 
the  actual  business  in  hand.  The  principle  of  the  steam 
engine  is  understood  by  the  ten-year-old  boy — the  appli- 
cation has  been  one  of  the  biggest  problems  in  industrial 
history. 


476 


PRINCIPLES  OF  BUSINESS 


The  advertiser's  problem  is  to  induce  purchase:  if  he 
does  that,  he  succeeds;  if  not,  he  fails.  The  process  of 
inducing  purchase  may  be  aptly  illustrated  by  a  rough  dia- 
gram, wherein  the  prospective  purchaser  (at  the  left)  and 
the  advertiser  are  to  be  considered  as  playing  a  friendly 
little  game. 

The  game  starts  with  the  purchasers  halted  at  Atten- 
tion. Then  the  advertiser  manoeuvres  so  as  to  lead — 
not  drive — his  crowd  in  the  direction  of  the  arrow,  till 
they  finally  enter  the  area  of  Action,  when  the  game  is 
won. 


Attention        Interest        Desire         Conviction 


Action 


The  advertiser  expects  to  lose  the  very  great  majority 
of  the  games  because  of  the  wide  openings  at  the  sides, 
through  which  the  quarry  *is  prone  to  escape.  A  slip  on 
his  part  inevitably  results  in  a  stampede  from  the  areas  of 
influence  to  the  outside,  whereupon  the  game  begins 
anew. 

We  are  now  about  to  consider  how  most  effectively  to 
attract  attention,  arouse  interest,  suggest  a  desire,  effect 
conviction,  and  force  action. 

What  attracts  attention. — Recall  a  dozen  objects, 
people,  or  situations  that  drew  your  attention  as  you 
walked  along  the  street  today,  and  find  out  for  yourself, 
if  you  can,  why  those  particular  objects,  or  people,  or 
situations,  rather  than  others,  impressed  themselves  upon 


ADVERTISING  A77 

your  mind.  The  stimulus  in  some  cases  was  due  to  the 
unusual — you  would  not  have  failed  to  remark  a  man 
walking  on  his  all-fours;  others  penetrated  through  the 
threshold  of  consciousness  because  of  the  contrast  they 
presented — a  big,  black  dog,  say,  playing  with  a  tiny 
white  fice;  others,  it  should  be,  claimed  a  share  of  your 
attention  by  reason  of  their  symmetry  of  form  and 
harmony  of  color — a  pretty  face,  for  instance;  others 
still  owed  their  power  to  association — a  picture  of  a  camp- 
ing party  reminded  you  of  your  last  summer's  week  in  the 
woods. 

Here,  then,  we  have  the  groundwork  to  build  upon : 
The  more  unusual,  the  more  strongly  contrasted,  the 
more  closely  associated  with  past  experiences,  the  more 
symmetrical,  or  harmonious,  or  rhythmic  the  objects  of 
attention  may  be,  the  more  forcefully  will  they  drive 
themselves  into  the  mind. 

What  attracts  favorable  attention. — The  advertiser 
makes  use  of  these  principles  in  every  advertisement  he 
writes ;  else  amid  the  hundreds  of  others  his  would  never 
be  read.  A  word  of  caution  is  needed  just  here:  the 
beginner  must  not  strain  his  energies  toward  extremes — 
not  every  effort  that  attracts  attention  will  produce  good 
results.  A  picture  of  two  men  scuffling  for  possession  of 
a  carton  of  breakfast  cereal  might  challenge  your  atten- 
tion, but  it  would  repel  because  of  the  subconscious  feel- 
ing that  you,  in  some  way  or  other,  were  being  associated 
in  the  advertiser's  thoughts  with  men  of  that  ilk.  The 
images,  whether  illustrations  or  letter  press,  must  needs 
please;  otherwise  more  harm  than  good  befalls.  This  is 
the  reason  why  advertising  pictures  represent  humanity 


478'  PRINCIPLES  OF  BUSINESS 

as  healthy,  joyous,  prosperous,  well-dressed  or  good-look' 
ing.  Never  should  the  sick,  the  wretched,  the  failures, 
the  ill-dressed  appear — except  to  be  contrasted  zvith  their 
opposites,  and  even  then  the  emphasis  should  always  fall 
on  the  pleasant  side  of  the  picture.  The  looker  or  reader 
must  be  led  to  identify  himself  (at  least  potentially)  with 
the  fortunate  classes  of  men  and  women. 

Furthermore,  it  is  not  enough  merely  to  please.  There 
must  be  some  relevancy  between  the  attention-compelling 
part  of  the  advertisement  and  its  primary  purpose — the 
sale  of  goods.  A  picture  of  a  pretty  girl — if  she  be  pretty 
enough — will  attract  attention  anywhere,  and  the  effect  is 
always  pleasing.  This  would  be  a  poor  way,  however, 
to  advertise  a  concrete  mixer  in  a  trade  journal.  The 
image  leads  away  from  the  concrete  mixer  rather  than 
towards  it — a  fatal  blunder. 

What  arouses  interest. — While  the  diagram  and  out- 
line seem  to  indicate  that  attention  and  interest  are  two 
separate  and  distinct  entities,  yet  in  actual  practice  inter- 
est follows  attention  in  a  flash  or  not  at  all ;  there  is  no 
appreciable  interval  of  time  elapsing  between  the  two, 
and  they  seem  to  be  synchronous.  In  fact,  it  is  not  going 
too  far  to  say  that  arousing  interest  is  not  a  very  differ- 
ent process  from  sustaining  attention,  as  attention  cannot 
be  held  unless  interest  wakens. 

Human  interests,  you  may  be  inclined  to  think,  vary  so 
with  individuals  that  a  catalogue  of  all  of  them  would 
assume  the  proportions  of  a  dictionary — and  so  it  would. 
Despite  the  truth  of  this,  however,  we  shall  not  find  the 
working  list  so  very  formidable.  As  the  thousands  of 
species  in  the  animal  world  can  be  grouped  into  genera, 


ADVERTISING  479 

or  as  automobiles,  carriages,  coupes,  victorias,  wagons 
and  pushcarts  can  be  classed  as  vehicles,  so  the  various 
objects  of  human  interest  may  be  generalized. 

Curiosity,  one  example. — An  advertiser  once  inserted 
a  large  "?"  and  nothing  else  in  a  prominent  position  of  an 
evening  paper.  What  effect  did  it  have?  Why,  it  cer- 
tainly compelled  attention — there  was  scarcely  a  reader 
who  could  have  failed  to  notice  it.  It  did  more  than 
that :  it  aroused  "that  low  vice,  curiosity,"  even  in  the 
cultured  breasts  of  those  readers  who  were  nettled  by  the 
impudence  of  the  appeal. 

Curiosity  is  a  powerful  instinct,  when  it  can  be  stimu- 
lated. It  is,  however,  too  wayward  and  freakish  an  aid 
to  rely  upon  exclusively,  although  the  elements  of  it 
are  certainly  present  in  every  interesting  advertisement. 
Experience  proves  that  the  practical  value  of  puzzles, 
tricks,  conundrums,  and  jokes,  formerly  so  common  in 
advertising  pages,  is  inconsiderable.  They  cannot  be 
made  to  assume  any  vital  relation  between  buyer  and 
seller,  unless  puzzles,  riddle-books,  tricks  and  jest-books 
be  the  commodity. 

The  saner  and  safer  bids  lie  along  the  lines  of  human 
interest — self-interest,  that  is  to  say,  and  this  about  sums 
it  all  up;  for  whether  a  man  spends  money  upon  himself 
individually,  or  upon  his  family,  his  firm,  or  his  friends, 
he  is  in  one  sense  making  the  outlay  for  his  own  benefit. 
Nor  is  this  a  sordid  view  to  take  of  the  matter,  for  in  so 
doing  he  is  making  "their  weal  his  weal  and  their  woe 
his  woe."  The  point  is  simply  this:  considered  eco- 
nomically, a  man's  expenditure  of  money  is  made  as  upon 
himself,  with  self-interest  as  the  actuating  motive.     Pa- 


48o  PRINCIPLES  OF  BUSINESS 

triotism  and  philanthropy  appear  to  be  the  only  excep- 
tions, and  they  have  not  been  commercialized. 

Self-interest,  comprehending  within  itself  a  whole  host 
of  other  hyphenated  self-compounds,  aims  at  health, 
wealth,  honor,  ability,  comfort,  comeliness,  pleasure. 
Here  we  have  the  catalogue  of  goods  or  evils  in  search 
of  which  the  sons  of  men  spend  their  days  and  nights  and 
years  in  toiling  and  struggling,  for  which  they  descend 
into  the  depths  of  earth  and  sea,  or  scale  the  sky. 

Talk  on  these  things :  if  you  can  but  toucli  these  chords 
(there's  the  rub!),  then  interest  is  already  engaged — they 
have  been  waiting  for  you  this  weary  while.  Whether 
you  are  advertising  a  sky-scraper  or  a  new  face-cream, 
yours  will  be  an  attentive  audience. 

Suggesting  desire. — To  pass  from  interest  to  desire 
the  trick  is  only  that  of  pressing  the  loud  pedal — continu- 
ing the  siren  music  in  the  same  key  and  tempo.  The  inter- 
est must  be  sustained  till  the  audience  see  themselves,  in 
fancy,  as  possessing  this  or  that  commodity  which  seems 
so  good  a  thing  "to  have  and  to  hold." 

Behold  yourself  well  again,  like  the  man  in  the  picture! 

See  how  beautiful  you  can  become ! 

Enjoy  yourself  among  the  lakes  and  mountains! 

Here  is  a  way  to  double  your  income ! 

Fragrance  like  a  breath  from  Araby — what  a  ciga- 
rette I 

The  easiest  easy  chair  that  ever  was ! 

These  are  examples  of  appeals  to  desire,  not  of  actual 
advertisements,  which  must  be  more  concrete,  must  follow 
the  arrow  straight  into  the  area  of  conviction  in  favor  of 
the  particular  good   offered.      The   advertisement   now 


ADVERTISING  481 

narrows  and  concentrates  itself  upon  some  of  the  superior 
advantages  (not  too  many  at  a  time,  frequently  only 
one),  abandons  the  pure  human-interest  part  of  the  field, 
which  relies  upon  emotion  for  its  effectiveness,  and  strikes 
straight  ahead  at  the  reason  for  choosing  it  in  preference 
to  all  others.  Some  of  these  reasons,  it  may  be,  are  not 
particularly  valid,  but  the  prospective  purchaser  is  not 
infrequently  swept  off  his  feet  by  such  phrases  as  :  "Old- 
est piano  makers  in  America,"  "Biggest  shoe  plant  in  the 
world,"  "Sold  enough  tires  last  year  to  encircle  the 
moon,"  "Original  makers  of  Tar  Candy — all  others  are 
imitations."  Appeals  of  this  sort  are  well  enough  occa- 
sionally, as  the  superlatives  of  bigness  hold  a  fascination 
for  the  human  mind.  They  have,  mostly,  turned  stale 
and  hackeyed  and,  if  employed  at  all,  must  depend  for 
success  upon  freshness  or  novelty  of  treatment. 

Buyers  are  becoming  more  critical  and  discriminating, 
too;  why  should  I  care  whether  a  pair  of  shoes  was  made 
in  the  biggest  or  eleventh  biggest  factory  in  the  country, 
so  long  as  they  fijt,  are  neat  in  appearance,  durable,  and 
equitably  priced?  Milady,  mayhap,  prefers  the  stylish 
and  chic  in  boots  to  all  the  other  excellencies  a  shoemaker 
ever  put  into  a  piece  of  leather  and  paper. 

Here,  then,  is  a  lesson  worth  learning.  Purchasers  of 
shoes  need  to  be  reminded  that  "our"  shoes  are  the  best, 
in  material  and  workmanship,  are  warranted  to  wear  a 
given  length  of  time,  are  guaranteed  to  fit  and  to  be  com- 
fortable ;  represent  the  best  value  for  the  money ;  and, 
finally,  are  up  to  the  minute  in  style.  These  claims  are 
sometimes  supported  by  a  testimonial  from  some  promi- 
nent personage,  but  more  frequently  by  cleverly  written 


482  PRINCIPLES  OF  BUSINESS 

little  "selling  talks"  about  this  new  process  of  leather 
treatment  or  that  great  foot-fitting  discovery.  Again, 
the  prospective  purchaser  is  told  how  he  is  protected  by 
an  elaborate  factory-test  against  every  flaw  in  the  leather, 
and,  yet  again,  milady  may  rest  assured  that  her  dainty 
foot,  thus  shod,  will  meet  with  an  approving  smile  in  the 
fashionable  world — "our"  expert  boot  creators  will  have 
seen  to  that. 

Forcing  action. — The  reader,  if  he  has  been  con- 
vinced, now  stands  in  the  attitude  of  waiting,  he  believes 
that  he  can  hardly  afford  to  be  without  the  commodity. 
Delay  means  a  gradual  fading  out  from  his  mind  of  all 
his  good  intentions :  they  must  speedily  be  translated  into 
action,  or  the  whole  business  must  be  repeated  from  start 
to  finish.  "Now,"  "here,"  and  "do"  are,  as  unobtru- 
sively as  possible,  forced  upon  him.  "Just  sign  this  cou- 
pon and  our  agent  will  call;"  "If  you  order  at  once,  we 
will  include,  absolutely  free,  a  five-volume  set  of  Kip- 
ling;" "After  September  first  we  shall  be  compelled  to 
advance  the  price;"  and  "There  are  only  93  of  these  suits 
left"  are  familiar  types  of  the  cruder  efforts  at  forcing 
action. 

BIBLIOGRAPHY 

Bridgewater,  Howard,  Advertising. 

Deland,  Lorin  F.,  Imagination  in  Business. 

Farrar,  Gilbert  P.,  The  Typography  of  Advertisements  that  Pay. 

Scott,   Walter   Dill,  Influencing  Men  in  Business. 

Scott,   Walter   Dill,    The    Theory   of  Advertising. 

French,  George,  Advertising. 

Hollingsworth,  H.  L.,  and  Hotchkiss,  George  B.,  Advertising  and 
Selling. 

Higham,  Charles  F.,  Scientific  Distribution. 

Tipper,  Hollingsworth,  Hotchkiss  and  Parsons,  Advertising,  Its 
Principles  and  Practice. 

Cherington,  Paul  T.,  Advertising  as  a  Business  Force. 

Balmer,  Edwin,  The  Science  of  Advertising. 


CHAPTER    XXII 

TRAFFIC 

Distinction  between  traffic  and  transportation. — 

"Traffic,  properly  the  interchange  of  goods  or  merchan- 
dise between  persons,  communities,  or  countries;  com- 
merce or  trade." — Encyclopcsdia  Britannica,  eleventh  edi- 
tion. 

Transportation,  which  is  by  some  writers  employed  as 
a  synonym  of  traffic,  is  rather  an  application  of  means  to 
traffic :  we  may  further  classify  the  distinction  by  observ- 
ing that  the  term  traffic  concerns  itself  with  the  what  and 
the  term  transportation  with  the  how  of  the  subject. 

The  origin  of  transportation  charges. — If  we  ex- 
clude from  consideration  the  transmission  of  information 
and  the  movement  of  persons  from  place  to  place,  we  shall 
discover  that  the  existence  of  the  great  network  of  rail- 
way and  steamship  lines  connecting  the  most  distant  parts 
of  the  inhabited  globe  with  one  another  and  representing 
an  annual  business  of  billions  of  dollars,  begins  and  ends 
with  a  very  fundamental  economic  principle ;  namely,  the 
difference  in  place-value  of  commodities.  "On  this  hang 
all  the  law  and  the  prophets." 

Were  a  load  of  cotton  as  valuable  in  the  Texas  cotton 
field  as  at  the  gin,  whither  it  must  be  hauled  before  its 
first  advance  in  form-value  can  take  place,  neither  time 
nor  labor  nor  money  would  be  expended  to  move  it ;  were 
the  bales  as  valuable  at  the  gin  as  the  local  town  market, 

483 


484  PRINCIPLES  OF  BUSINESS 

it  would  never  leave  the  gin  yard ;  were  it  as  valuable,  in 
short,  at  any  of  its  halting  places  on  the  way  to  the  con- 
sumer as  at  the  next  stage,  there  would  be  no  next  stage, 
and  the  cotton  would  cease  its  globe  trotting — does  as  a 
matter  of  fact,  whenever  one  more  trip  will  not  increase 
its  value  beyond  the  cost  of  movement. 

The  relation  between  the  carrier  and  the  shipper  on  the 
one  hand  and  the  consignee  on  the  other  consequent  upon 
the  passage  of  freight  from  the  shipper  through  the  hands 
of  the  carrier  to  the  consignee  is  a  complex  one.  The 
gist  of  the  situation  is  summed  up,  not  so  much  in  the 
question,  "Who  pays  the  freight?"  as  in  the  answer  to 
the  more  vital  questions,  "How  much  are  the  freight 
charges?"  and  "On  what  basis  are  these  charges  to  be 
levied?" 

The  reimbursement  which  the  carrier  is  entitled  to  re- 
ceive for  services  rendered,  or,  viewed  from  Jones's  angle 
of  vision,  the  price  that  must  be  paid  to  the  carrier,  soon 
appears  as  the  backbone  of  the  whole  skeleton — a  veri- 
table bone  of  contention  it  has  proved  to  be,  this  matter 
of  rate-making  and  rate-fixing. 

Whether  this  or  that  commodity  can  be  shipped  profit- 
ably from  a  point  where  its  place-value  is  low  to  another 
point  where  its  place-value  is  somewhat  or  much  higher 
depends  upon  transportation  rates.  If  X  =  the  value  of 
the  commodity  at  the  first  point,  Y  =  its  value  at  the 
second  point,  and  Z  =  cost  of  transportation,  no  move- 
ment will  take  place,  unless  X  -f-  Z  is  less  than  Y.  This 
is  necessarily  so;  otherwise  buyers  and  sellers  (one  or 
both)  would  be  losing  money  on  every  transaction  or  else 
be  engaged  in  merely  "swopping  dollars"  for  the  fun  of  it. 


TRAFFIC  485 

The  controlling  principles  of  commodity  movement 
may  be  illustrated  by  comparing  the  various  markets  to 
reservoirs,  the  commodities  themselves  to  water,  and  the 
means  of  transportation  to  pipes  interconnecting  the 
reservoirs  one  with  another.  Filling  a  reservoir  results 
in  a  movement  of  water  from  it  through  the  pipes  to  other 
reservoirs  which,  if  the  process  be  continued,  will  cease 
only  when  the  water  has  reached  the  lowest  level  fur- 
nished with  an  outlet  pipe.  Now,  conceive  each  pipe  to  be 
fitted  with  a  valve  offering  a  resistance  of,  say,  ten 
pounds  to  the  square  inch  against  the  current.  What  will 
happen?  Obviously,  the  passage  of  water  will  not  be- 
gin till  the  pressure  exceeds  ten  pounds  to  the  square  inch ; 
will,  in  proportion  as  the  water  pressure  is  increased  by 
additions  of  water,  flow  more  and  more  rapidly ;  and, 
finally,  will  cease  entirely  whenever  the  valves  close  as  a 
result  of  less  than  ten  pounds  of  pressure  against  them. 
The  valves  are  the  counterpart  of  transportation  rates, 
set  at  all  degrees  of  pressure-tension,  some  just,  others  un- 
just; some  reasonable,  others  unreasonable. 

The  basis  of  carriers'  rates. — It  is  very  evident,  even 
from  so  hasty  an  examination,  that  the  very  existence  of 
many  industries  depends  solely  upon  the  transportation 
rates  which  their  "captains"  are  able  to  secure;  it  is  also 
evident  that  any  advance  in  transportation  rates  to  and 
from  certain  points  might  very  speedily  throw  a  great 
business  concern  into  bankruptcy. 

What  is  the  basis  actually  used  in  making  and  fixing 
rates?  What  basis  ought  to  be  so  used?  These  are 
questions  which  the  reader  may  reasonably  be  supposed 
to  ask  himself  at  this  juncture. 


486  PRINCIPLES  OF  BUSINESS 

In  answer  to  the  first  question,  before  considering  it 
at  greater  length,  it  must  be  said  that  there  has  never  been 
any  unified  movement  on  the  part  of  shippers,  carriers, 
consumers  and  boards  of  rate  control  to  adjust  transpor- 
tation rates  on  a  really  scientific  basis ;  the  tariff  books 
are  somewhat  like  Topsy — they  "just  growed"  to  be  what 
they  are.  Where  not  purely  arbitrary,  they  are  the  result 
of  experience  correcting  guesswork  of  an  earlier  day — 
however,  only  glaring  injustices  to  certain  groups  of 
shippers,  carriers,  consumers,  and  communities  have  been 
remedied,  now  by  the  carriers  themselves,  now  by  courts, 
redressing  the  grievances  of  plaintift's,  and  again  by  stat- 
utes regulating  the  rates  directly,  and  yet  again  by  legis- 
latures. State  and  national,  creating  boards  and  commis- 
sions with  wide  discretionary  powers. 

Prior  to  the  age  of  railways,  transportation  by  land 
was  carried  on  mostly  by  carts  and  wagons  drawn  by 
horses  and  mules — a  slow,  laborious  and  expensive  proc- 
ess, precluding  utterly  the  transfer  of  any  considerable 
quantity  of  stuff  for  any  considerable  distance,  since  the 
cost  of  transportation  soon  became  prohibitive  in  the  case 
of  all  commodities  except  those  whose  value  was  very 
high  in  proportion  to  weight.  Silks  and  spices  are  no- 
table examj5les  of  such  goods,  which  were  transported 
long  distances  by  land  from  the  Far  East  to  the  Medi- 
terranean and  thence  by  boat  to  the  Italian  cities  for 
distribution  over  Europe. 

But,  except  in  the  case  of  luxuries,  itransportation 
revenues  were  a  small  item  in  the  business  of  the  world — ■ 
goods  did  not  move  far.  Life  was  simple,  wants  few; 
the  necessities   were  produced  in,   or  near,   each   com- 


TRAFFIC  487 

munity.  None  but  the  rich  could  expect  luxuries,  and 
they  not  many. 

We  must  regard  the  invention  of  the  steam  engine  as 
marking  the  beginning  of  the  greatest  revolution  in 
human  life,  employment  and  habits  that  our  planet  has 
ever  known.  It  ushered  in  the  industrial  age,  and  within 
less  than  a  hundred  years  after  the  construction  of  the 
first  locomotive  changed  the  face  of  society  more  than 
all  the  forces  of  the  past  had  been  able  to  change  it  in 
three  thousand  years. 

No  application  of  the  steam  engine's  energy  has  had 
an  influence  more  powerful  than  that  comprehended  in 
the  expression,  "railway  systems;"  with  the  construction 
of  railroads  came  a  breaking  down  and  disintegration  of 
the  old  economic  order.  People  found  it  economical  to 
produce  more  goods  of  a  certain  kind  than  they  them- 
selves, and  later,  more  than  their  communities,  could  use 
— and  to  give  up  making  other  goods,  such  as  the  rail- 
road could  deliver  to  them  from  other  places  at  a  lower 
cost  than  that  at  which  they  could  produce  them  them- 
selves. This  represents  the  first  step  in  the  evolution  of 
specialized  industries,  which  has  now  reached  the  stage 
where  certain  products  in  universal  use  are  almost  ex- 
clusively supplied  to  a  whole  nation  by  a  single  corpora- 
tion. The  business  of  many  of  these  corporations 
amounts  annually  to  hundreds  of  millions  of  dollars  each, 
and  they  furnish  employment  to  hundreds  of  thousands 
of  workers. 

From  this  point  onward,  till  the  subject  of  express  com- 
panies is  reached,  the  traffic  question  is  discussed  with 
special  reference  to  railroads  as  common  carriers.     The 


488  PRINCIPLES  OF  BUSINESS 

economic  aspect  is,  in  general,  the  same  for  all  classes  of 
transportation  agencies. 

What  is  the  economic  relation,  on  the  one  hand,  be- 
tween the  railroads  and  the  producers,  and  on  the  other 
hand,  between  the  railroads  and  the  consumers,  both  of 
whom  the  carrier  may  serve  at  one  and  the  same  time? 
But  more  specifically,  this  question  is  a  repetition  of  the 
rate  question. 

Perhaps  we  shall  better  understand  the  situation,  if  we 
try  to  discover  w4iat  the  different  parties  would  wish  to 
have  were  the  decision  left  for  them  to  make.  We  may 
be  reasonably  sure  that  in  the  conflict  of  interests  between 
the  carriers  and  the  rest  of  the  public  each  side  endeavors, 
so  far  as  it  can,  to  approximate  that  ideal. 

Given  a  free  hand,  the  carriers  will  naturally  fix  or  shift 
the  rate  to  the  exact  level  that  will  yield  them  the  maxi- 
mum of  profit  on  their  investment.  Their  endeavor  will 
be  to  make  the  rate  just  low  enough  not  to  force  them  to 
add  to  their  physical  equipment  and  man-power  before 
they  believe  such  additions  will  assure  them  proportion- 
ately higher  net  earnings,  and  just  high  enough  not  to 
throw  into  disuse  money-making  equipment  already  avail- 
able. "What  the  traffic  will  bear"  is  the  term  applied  to 
this  system  of  rate-making,  which  represents  the  ideal  of 
the  carrier.  It  is  the  system  that  railways  actually  have 
adopted,  in  so  far  as  they  can  apply  it  in  estimating  the  re- 
sults of  their  charges. 

The  business  ideals  of  the  rest  of  the  economic  world 
— shippers,  producers,  manufacturers,  or  consumers — ■ 
tend  toward  the  opposite  extreme.  They — most  of  them, 
at  least — would,  if  it  were  in  their  power,  beat  down  the 


TRAFFIC  489 

rates  on  all  commodities  to  the  "uttermost  farthing," 
thereby  reducing  the  net  earnings  of  the  transportation 
companies  to  the  very  lowest  level  that  would  not  mean 
poor  service  to  themselves  or  absolute  bankruptcy  to  the 
companies.  They  would  then,  as  they  have  done  in  the 
past,  enter  a  class,  commodity,  and  territory  war  with  one 
another  for  the  points  of  vantage,  battling  to  secure— each 
for  himself,  his  business,  or  his  city — every  possible  and 
impossible  concession,  even  to  the  point  of  shifting  a 
burden  unfairly  upon  some  other  part  of  the  public. 
"Every  man  for  himself,  and  the  devil  take  the  hindmost" 
not  unfairly  characterizes  their  attitude. 

Justice  lies  somewhere  in  the  neutral  zone  between 
these  two  poles — just  where,  nobody  has  yet  been  able  to 
determine.  Quite  evidently  the  solution  lies  hidden  in 
the  answer  to  the  question.  How  can  rates  be  adjusted 
so  that  compensation  may  be  made  equal  in  value  to  the 
value  of  service  rendered  ?     This  is  the  desideratum. 

But  the  term  service  looks  in  two  directions — has  a 
double  significance.  Is  the  service  to  be  weighed  on  the 
seller's  or  the  buyer's  scales?  Quite  aside  from  the 
well-known  proverb  that  sellers'  weights  are  heavy  and 
buyers'  light,  it  may  actually  cost  the  seller  a  great  sum 
to  render  a  service  which  may  be  of  trifling  value  to  the 
buyers,  and  vice-versa.  The  service  thus  changes  its 
value  in  passing  from  one  to  the  other. 

Consider  this  extreme  case :  An  American  fleeing 
from  Mexico  during  the  disturbances  there  willingly 
and  eagerly  paid  an  old  boatman  three  hundred  dollars 
to  row  him  across  the  Rio  Grande — a  stream  not  three 
hundred  yards  wide;  the  refugee  was  in  no  particular 


490  PRINCIPLES  OF  BUSINESS 

danger  at  the  time — but  he  thought  he  was,  and  the 
Mexican  boatman  showed  no  disposition  to  calm  his 
alarm.  Now,  in  this  case,  the  service  rendered  to  the 
American,  in  relief  from  mental  anguish,  was  worth — 
according-  to  his  own  statement — three  hundred  dollars, 
but  the  service  rendered  ^3'  the  Mexican  was  not  worth 
even  three  dollars. 

This  may  appear  to  be  a  piece  of  juggling;  it  will  serve, 
however,  to  help  us  in  our  search  for  a  firm  foundation 
to  build  upon.  In  the  incident  just  recited  no  one  in  his 
senses — the  hero  alone  excepted — can  doubt  that  the 
boatman  was  guilty  of  cheating. 

In  making  rates,  carriers  have  not  neglected  to  take  into 
consideration  both  sides  of  this  two-headed  question  of 
service,  being  prone  to  charge  for  service  received, 
when  such  service  is  very  valuable  to  the  recipient,  but 
for  service  rendered  when  it  is  expensive  for  them  to 
render.  This  is  but  another  application  of  the  what- 
the-trafific-will-bear  system,  sugar-coated  in  each  instance 
to  make  it  palatable.  There  are  two  partially  restraining 
influences  acting  to  prevent  the  realization  of  this  aim — 
competition  and  legislation,  the  latter  affecting  more 
especially  the  railroads  and  express  companies. 

We  shall  now  enumerate  and  discuss  the  different  fac- 
tors that  enter  into  the  fixing  of  railway  rates.  In  doing 
so  we  shall  present  only  generally  the  way  in  which  our 
system  has  grown  up.  It  must  be  remembered  that  the 
matter  is  wholly  within  the  hands  of  the  Interstate  Com- 
merce Commission  and  that  the  elements  that  enter  into 
the  fixing  of  a  specific  rate  on  a  specific  commodity  for 
a  specific  distance,'  that  is,   from  one  place  to  another 


TRAFFIC  491 

definite  place,  are  not  simple.  The  interests  of  the  public 
must  be  considered,  those  of  the  shipper  cannot  be 
neg-lected,  and  the  railroad  must  be  permitted  to  earn 
such  a  return  on  its  investment  as  will  attract  new  capital 
to  satisfy  the  ever  expanding  needs  of  a  growing  institu- 
tion. 

It  might  seem  that  the  charge,  in  each  and  every 
transaction,  should  be  based  upon  the  cost  of  performing 
the  service  contracted  for:  this,  in  the  first  place,  is  im- 
possible to  determine ;  all  the  rate  experts  in  the  country 
could  not  figure,  jointly  or  severally,  the  cost  to  the  rail- 
road companies  of  carrying  a  ton  of  potatoes  from 
Aroostook,  Maine,  to  New  York  City.  In  fact,  the  cost 
would  necessarily  vary  on  different  days,  even  if  it  could 
be  ascertained.  Even  the  average  cost  of  hauling  ten 
thousand  tons  of  potatoes  in  single-ton  lots,  which  would 
be  a  fairer  basis  to  employ  in  levying  the  charge,  does  not 
admit  of  determination.  The  outlay  and  income  resulting 
from  railway  business  are  both  distributed  among  so 
many  forces,  all  interrelated  with  one  another,  that  no 
one  can  say  just  what  effect  here  will  follow  a  certain 
change  there.  Only  general  principles  can  be  applied. 
One  authority  has  well  said  that  rate-making  is  a  matter, 
not  of  mathematical  formulae,  but  of  sound  judgment. 

The  bases  of  the  two  fundamental  principles  of  rate- 
making  are,  accordingly : 

1.  What  the  traffic  will  bear. 

2.  Cost  of  service. 

In  the  United   States   elements   of  both   systems   are 

discoverable  in  the  tariff  rates  and  classification  sheets. 

We  see  an  exemplification  of  the  former  when  cotton 


492  PRINCIPLES  OF  BUSINESS 

from  the  South  comes  to  the  North  at  a  low  rate,  and 
later  in  the  form  of  cloth  goes  back,  it  may  be  to  the 
same  county,  at  a  very  much  higher  rate.  The  justifica- 
tion is  that  the  ratio  of  value  to  weight  has  changed — 
that  is  to  say,  value  of  the  commodity  enters  into  the 
question.  Except  for  a  slightly  increased  expense  in 
loading  at  terminals  and  the  added  insurance  risk  due  to 
increase  in  commodity  value,  it  costs  the  railroads  no 
less  to  haul  a  car  of  raw  cotton  from  Atlanta  to  New 
York  than  to  haul  a  car  of  manufactured  cotton  goods 
from  New  York  to  Atlanta.  It  is  expedient  to  make  this 
apparent  discrimination  (and  thousands  of  others  of  a 
similar  nature) — expedient  alike  for  the  carriers  and 
the  public,  in  much  the  same  way  that  a  graduated  in- 
come tax  may  be  expedient. 

Rates  based  on  "w^hat  the  traffic  will  bear." — The 
principal  influences  affecting  transportation  charges,  as 
we  have  seen,  are  (i)  what  the  traffic  will  bear,  and  (2) 
cost  of  service.  We  consider  first  the  factors  included 
under  "what  the  traffic  will  bear." 

I.  Value  of  the  commodity. — The  principle  under 
which  rates  are  based  partly  upon  the  value  of  the  com- 
modity transported  is  an  important  one,  and  in  its  work- 
ings is  not  unlike  that  of  taxation.  While  it  may  not 
cost  the  railroads  more  to  handle  a  carload  of  manu- 
factured cotton  goods  (beyond  a  slight  allowance  for 
extra  insurance-risk)  than  to  handk  a  carload  of  raw 
cotton,  they  have  found  by  experience  that  the  traffic 
will  bear  a  considerable  increase  in  rates.  The  ratio  of 
increase  in  such  rates  is  so  small  in  proportion  to  the 
value  of  the  goods  that  it  appears  quite  negligible  to 


TRAFFIC  493 

wholesale  dealers  and  jobbers,  who  find  no  trouble  in 
passing  it  on  down  the  line  to  the  consumers. 

(2)  Competition. — Competition,  especially  between 
water-way  and  railroad  carriers,  which  railroads  must 
meet,  is  the  chief  factor  in  determining  the  rates  between 
points  accessible  by  both  boats  and  railways.  Transpor- 
tation by  water  is  naturally  less  expensive  than  trans- 
portation by  land,  a  condition  due  mainly  to  the  fact 
that  nature  has  provided  the  water-way,  whereas  the 
artificial  roadbeds  which  man  has  constructed  represent 
an  outlay  of  hundreds  of  millions  of  dollars.  Grading, 
tunnelling,  bridging,  steel  trackage,  upkeep — all  these 
demand  vast  expenditures  of  wealth  with  which  river, 
coastwise,  and  ocean  traffic  does  not  concern  itself. 

If  the  Boston-San  Francisco  rates  were,  car  for  car 
and  mile  for  mile,  proportioned  to  the  Boston-Indian- 
apolis rates,  the  railroads  would  get  practically  none  of 
the  business — nearly  all  the  freight  would  move  by  water 
via  the  Panama  Canal.  In  this  case  the  roads  are  per- 
mitted to  meet  the  water  rates,  are  even  allowed  in  doing 
so  to  make  a  lower  rate  to  San  Francisco  than  that  in 
effect  from  Boston  to  California  points  through  which 
the  freight  must  pass  to  its  destination. 

California  and  Nevada  towns  have  not  unnaturally 
complained  that  they  are  the  victims  of  discrimination — 
that,  if  the  railroad  companies  are  making  money  out 
of  the  haul  from  Boston  or  New  York  to  San  Francisco, 
it  proves  that  their  tariffs  for  intermediate  points  are 
exorbitant.  The  answer  to  this  has  been  that,  as  a  re- 
sult of  this  apparent  favoritism  to  San  Francisco,  the 
railrcads  are  able  to  make  a  small  profit  per  car  (amount- 


494  PRINCIPLES  OF  BUSINESS 

ing  in   the   aggregate   to   a  considerable   sum)    on   San 
Francisco  traffic — a  sort  of  by-product,  so  to  speak, — 
which  adds  to  their  net  earnings;  that,  deprived  of  this 
additional  business,  they  would  be  compelled  to  raise  the 
rates  to  intermediate  points  far  above  what  they  are  now. 
In  general,  the  same  arguments  will  justify  apparent 
discrimination    against    intermediate    points    by    round- 
about railways,  competing  with  direct  routes  for  a  share 
of  through  traffic.     Prior  to  the  passage  of  the  Inter- 
state Commerce  Act,  one  paragraph  of  which  is  quoted 
below,   railroads  not  infrequently  discriminated  against 
their  own  intermediate  points  in  non-competitive  hauls. 
".  .  .  It  shall  be  unlawful  for  any  common  car- 
rier subject  to  the  conditions  of  this  Act  to  charge 
or  receive  any  greater  compensation  in  the  aggre- 
gate for  the  transportation  of  passengers,  or  of  like 
kind  of  property,   for  a  shorter  than  for  a  longer 
distance  over  the  same  line  or  route  in  the  same 
direction,    the    shorter    being    included    within    the 
longer  distance,  or  to  charge  any  greater  compen- 
sation as  a  through  rate  than  the  aggregate  of  the 
intermediate  rates  subject  to  the  provisions  of  this 
Act;  but  this  shall  not  be  construed  as  authorizing 
any  common  carrier  within  the  terms  of  this  Act 
to  charge  or  receive  as  great  compensation  for  a 
shorter  as  for  a  longer  distance." 
Rates  based  on  cost  of  service. — Various  costs  of 
service   and   other   similar    factors   which   influence   the 
rates  are  the  following: 

I.  Capitalisation,  operating  and  overhead  expenses. — 
Among  the  costs  of  service  which  must  be  taken  into 


TRAFFIC  495 

consideration  are  comprehended,  such  items  as  interest 
on  the  capital  investment,  maintenance  of  way  and  equip- 
ment, as  well  as  operating  expenses  and  other  variable 
or  fixed  charges.  These  expenditures  do  not  vary  di- 
rectly as  the  volume  of  business;  it  has  been  estimated 
that  not  more  than  a  third  of  the  outlay  of  a  railroad 
bears  a  fixed  ratio  to  the  amount  of  business.  Or,  put 
in  other  words,  two-thirds  of  the  expenditures  must  be 
made  quite  independently  of  whether  the  road  is  hauling 
much  or  little. 

2.  Weight  and  density  of  commodities. — The  relation 
of  the  weight  and  density  of  the  commodities  to  the  cost 
of  service  is  so  evident  as  to  demand  no  further  com- 
ment. 

3.  Distance — The  length  of  the  haul  is  also  a  self- 
evident  factor. 

4.  Speed  of  transit. — The  time  element  is  frequently 
a  very  important  matter,  as  when  the  commodity  is  per- 
ishable, or  when  there  is  competition  between  shippers  of 
the  same  commodity  to  reach  a  market  early  in  the  season 
while  prices  are  high.  Early  in  June,  for  example,  there 
is  a  contest  between  the  cantaloupe  shippers  of  southern 
Texas  and  those  of  California  to  be  first  in  the  northern 
markets. 

5.  Amount. — Railroads,  as  sellers  of  transportation 
service,  in  common  with  other  sellers,  can  do  a  wholesale 
business  more  cheaply  per  unit  than  they  can  retail. 
Accordingly,  a  commodity  shipped  in  carload  quantities 
properly  takes  a  lower  rate,  ton  for  ton,  and  a  still  lower 
rate  in  train-load  lots. 

6.  Direction. — When  the  grain  shipping  season  is  at 


496  PRINCIPLES  OF  BUSINESS 

hand,  thousands  of  loaded  cars  begin  moving  from  the 
Mississippi  Valley  countr}^  to  the  East,  and,  after  dis- 
charging their  cargoes,  must  return  with  all  possible 
speed  to  be  reloaded.  These  westward  bound  trains  will 
at  such  a  time  necessarily  consist  of  "empties,"  and  rather 
than  dispatch  a  great  percentage  of  them  in  that  condi- 
tion, the  companies  are  willing  to  make  some  special 
rates  to  secure  westbound  freight — especially  such  as  re- 
quires stimulation  to  move  in  normal  times. 

Classification, — Classification  is  a  concrete  applica- 
tion of  the  matter  of  value,  perishability,  risk  and  other 
elements  affecting  the  commodity,  such  as  its  condition, 
form,  packing,  and  the  like.  Some  ten  or  twelve  thou- 
sand articles  appear  in  the  classification  books,  grouped 
into  from  six  to  fourteen  classes.  In  the  beginning  of 
railroad  transportation  in  this  country  each  road  was 
privileged  to  make  its  own  freight  classifications,  article 
by  article,  doing  as  might  seem  proper  and  expedient. 
With  the  expansion  of  the  transportation  system  and  the 
continued  linking  of  line  with  line  came  a  hopeless  con- 
fusion :  one  road  classified  a  commodity  one  way  and 
another  another,  until  neither  shippers  nor  carriers  were 
sure  of  their  ground  in  interline  traffic. 

Gradually  the  roads  in  certain  sections  adopted  the 
same  classification,  and  finally  the  whole  United  States 
was  divided  into  three  classification  territories,  viz.,  the 
Official,  including  territory  north  of  the  Ohio  and  Poto- 
mac rivers  and  east  of  the  line  separating  Illinois  from 
Indiana ;  the  Southern,  including  the  territory  south  of 
the  Ohio  and  Potomac  rivers  and  east  of  the  Mississippi; 
and  the  Western,   including  the   territory  west  of  the 


TRAFFIC  497 

Mississippi,  and  most  of  the  State  of  Illinois.  Each  of 
these  territories  has  a  classification  committee  composed 
of  appointees  of  the  various  roads ;  their  classification, 
like  their  rates,  are  subject  to  approval,  for  interstate 
business,  by  the  Interstate  Commerce  Commission.  Most 
of  the  States  also  have  State  railroad  commissions  pos- 
sessed of  powers  over  interstate  traffic  analogous  to  tiiose 
of  the  national  commission. 

If  you  should  wish  to  find  th«  rate  applying  to  a  given 
commodity,  you  would  first  have  recourse  to  an  alpha- 
betically arranged  classification  book  containing  a  list  of 
some  ten  or  twelve  thousand  articles,  to  discover  whether 
that  particular  thing,  in  that  particular  form,  packed  or 
crated  in  that  particular  way,  was  classified  as  first,  sec- 
ond— or  fourteenth  class  freight.  Then,  if  success- 
ful, you  would  refer  to  the  tariff  book  giving  the  local 
or  the  interline  (joint)  rate  on  freight  of  that  classifica- 
tion, weight,  and  quantity  destined  from  your  station  to 
the  consignee's  station. 

Freight  classifications,  however,  are  so  complicated 
because  of  overlappings  and  various  other  factors  en- 
tering into  the  problem,  that  the  assistance  of  an  expert 
is  often  needed  to  disentangle  the  knots ;  even  with  such 
aid  you  cannot  be  sure  you  have  the  most  advantageous 
classification.  Certain  commodities  under  slightly  dif-' 
ferent  names,  perhaps,  according  as  they  are  intended 
for  different  uses,  may  take  entirely  different  classifica- 
tions, with  a  corresponding  difference  in  the  rate  which 
applies. 

Commodity  rates. — A  very  important  exception  to 
the  classification  book  and  tariff  book  system  of  rating — 


498  PRINCIPLES  OF  BUSINESS 

comprehending,  indeed,  two-thirds  or  three-fourths  of  all 
railroad  traffic  (when  measured  by  tonnage) — is  to  be 
found  in  the  commodity  rate,  which  embraces  the  classi- 
fication, the  distance,  and  the  charge,  all  in  one.  His- 
torically it  represents  a  special  concession  made  by  the 
railroads  to  a  certain  city  or  section  of  the  country  in 
favor  of  some  one  commodity  destined  to  some  partic- 
ular point.  A  commodity  rate,  therefore,  specifies  one 
commodity,  from  a  given  station,  to  a  given  station,  at 
a  given  tariff,  per  hundredweight  or  per  minimum  car- 
load. It  serves  to  create  business  for  both  producers 
and  carriers,  since,  without  a  concession,  the  commodity 
would  not  move  at  all.  Justification  for  its  existence 
rests  upon  the  same  grounds  as  that  for  competitive 
rates;  namely,  that  the  earnings  of  the  roads  are  there- 
by augmented,  thus  permitting  them  to  keep  the  rates  on 
classified  freight  lower  than  would  otherwise  be  possible. 
Coal,  grain,  forest  products,  ore,  gravel,  cement,  and 
cotton  are  examples  of  commodities  taking  this  rate. 

Shipping  papers.— Accompanying  or  connected  with 
each  shipment  are  certain  documents,  the  most  important 
of  them  being  the  bill  of  lading  and  the  way  bill. 

Bill  of  lading. — When  freight  is  delivered  at  a  railway 
terminal  or  freight  station  for  shipment  it  is  usual  for 
the  agent  to  give  the  shipper  a  receipt  therefor,  although, 
it  is  not  really  necessary.  In  any  case  the  agent  will 
make  out  in  triplicate  a  bill  of  lading,  which  is  the  con- 
tract between  the  two  parties  to  the  transaction,  and,  as 
such,  requires  the  signature  of  an  agent  of  the  carrier 
and  of  the  shipper  or  an  agent  acting  for  him.  Two 
copies    (the   original   and   one   other)    are  given   to   the 


TRAFFIC  499 

shipper,  the  other  being  retained  by  the  agent.  It  is  cus- 
tomary for  the  shipper  to  transmit  the  original  to  the 
consignee,  who  presents  it  to  the  agent  at  his  station 
when  he  claims  the  freight.  Besides  the  signatures  and 
several  hundred  words  of  fine  print  reciting  the  terms 
of  the  contract  the  bill  of  lading  enumerates :  name  of 
shipper;  name  of  railway  company  accepting  the  freight; 
number  and  weight  of  pieces  in  the  shipment;  value,  to- 
gether with  a  statement  of  class  and  rate ;  route ;  destina- 
tion ;  name  of  consignee. 

Bills  of  lading  may  be  of  two  kinds— straight  or  order. 
The  essential  differences  are  these:  i.  The  straight  bill 
of  lading  permits  the  consignee  to  receive  the  freight  by 
merely  paying  the  charges  and  signing  for  it,  whereas  the 
order  bill  of  lading  holds  the  freight  subject  to  the  ship- 
per's order,  which  usually  means  that  he  is  withholding 
the  endorsed  original  bill  of  lading  until  he  receives 
payment  for  the  goods.  2.  The  straight  bill  of  lading  is 
a  non-negotiable  piece  of  paper;  the  original  of  the  order 
bill  of  lading  is  negotiable,  and,  when  endorsed  by  the 
shipper  with  draft  on  consignee  attached  may  be  dis- 
counted by  the  shipper  at  his  bank. 

Way  bill  or  zvay  card.— The  way  bill,  or  way  card, 
so  important  for  the  railroads,  contains  much  the  same 
information  as  the  bill  of  lading,  and  serves  as  a  sort  of 
routing  card  to  accompany  the  shipment;  it  is,  in  this 
respect,  not  dissimilar  to  the  coupons  of  a  passenger's 
ticket. 

Notice  of  arrival. — When  a  shipment  reaches  its  desti- 
nation, it  is  customary  for  the  agent  to  give  notice  to  the 
consignee,  who  may  receive  the  goods  by  surrendering 


500  PRINCIPLES  OF  BUSINESS 

the  bill  of  lading  and  paying  the  freight  charges,  itemized 
on  the  freight  hill,  which  the  agent  receipts. 

Demurrage. — Transportation  efficiency  cannot  be 
maintained  when  there  is  a  great  disparity  between  the 
volume  of  traffic  and  the  supply  of  cars  to  handle  the 
traffic.  From  the  standpoint  of  railroad  operation,  car 
shortage  and  car  surplusage  are  alike  indications  of 
waste;  shortage,  usually  seasonal,  means  that  the  roads, 
as  sellers,  are  out  of  goods  and  consequently  must  miss 
some  sales ;  'surplusage,  usually  seasonal  also,  means  that 
the  roads,  as  sellers,  have  too  much  goods  on  hand  and 
consequently  must  lose  money  on  idle  investments.  From 
the  standpoint  of  shippers,  surplusage  is  a  matter  of 
small  concern,  directly,  at  least;  but  shortage  may  result 
in  disaster  to  the  shipper  as  well  as  in  loss  to  the  carrier. 
A  charge,  known  as  "demurrage,"  therefore  is  assessed 
against  the  consignee  who  fails  to  unload  his  car  of 
goods  within  a  given  time.  The  tendency  is  toward  in- 
creasing the  demurrage  charges,  as  well  as  to  make  the 
charge  progressive  day  by  day  while  the  car  is  held  by 
the  consignee. 

Express  traffic. — The  general  principles  of  traffic  are 
the  same  for  the  express  system  as  for  the  freight  system 
discussed  in  the  preceding  pages.  The  essential  differ- 
ence lies  in  the  increased  efficiency  of  the  express  com- 
panies in  forwarding  commodities  at  a  high  rate  of 
speed.  The  present  condition  of  express  transportation, 
under  which  there  is  frequently  a  great  amount  of  delay 
in  transporting  and  delivering  express  shipments,  is  due, 
of  course,  not  to  the  speed  at  which  the  shipment  is  car- 
ried while  actually  in  movement  but  to  the  insufficiency  of 


TRAFFIC  501 

facilities  for  moving  the  shipment  at  all.  Freight  trains 
average  about  twelve  miles  per  hour,  whereas  express 
packages,  which  are  forwarded  on  passenger  trains,  may 
average  thirty  miles  an  hour.  There  is,  besides,  an  added 
convenience  in  shipping  by  express :  the  companies,  ex- 
cept in  very  small  towns,  deliver  the  packages  to  and 
from  the  house  making  or  receiving  the  shipment.  These 
advantages — particularly  speed  of  transit — necessarily 
result  in  making  express  rates  much  higher  than  freight 
rates  for  corresponding  commodities  and  distances. 

Eight  express  companies  (now  operated  by  the  Gov- 
ernment), each  contracting  with  a  railroad  system  for 
the  exclusive  right  of  forwarding  express  matter  on  the 
trains  of  that  company,  operate  more  than  three  hundred 
thousand  miles  of  road.  The  major  part  of  this  mileage 
is  covered  by  two  of  these  companies — the  Wells-Fargo 
and  the  American.  The  compensation  to  railroad  com- 
panies for  their  services  is  a  percentage,  specified  in  the 
contract,  of  the  gross  receipts  of  the  express  companies ; 
this  percentage  varies,  of  course,  under  different  condi- 
tions, density  of  population  in  the  section  served  being 
the  most  important  factor  in  fixing  it. 

In  1906  the  Hepburn  Act  and  in  1910  the  Mann-Elkins 
Act  declared,  in  effect,  that  the  express  companies  were 
common  carriers,  thus  bringing  them  under  control  of  the 
Interstate  Commerce  Commission.  The  commission  in 
1912  estabhshed  a  block  and  zone  system  dividing  the 
whole  country  into  districts  and  established  a  system  of 
rates  for  express  charges,  much  lower  than  those  in  effect 
prior  to  that  date. 

Most  commodities  shipped  by  freight  would  in  no  case 


502  PRINCIPLES  OF  BUSINESS 

move  by  express;  most  commodities  shipped  by  express 
would  not  move  by  freight.  Coal  and  diamonds  may  be 
taken  as  two  extremes  of  this  statement,  with  all  other 
commodities  occupying  points  in  the  line  between  the 
two  limits.  The  overlapping  is  less  than  we  should  be 
likely  to  imagine.  In  other  words,  in  most  instances 
whether  shipment  should  be  made  by  express  or  freight 
is  not  a  difficult  task  to  determine. 

Diamonds  Coal 

I  I 

I  All  commodities  | 

Express  

Freight 

Parcel  post. — On  January  i,  191 3,  the  Federal  Gov- 
ernment definitely  entered  the  field  as  a  competitor  of  the 
express  companies  by  establishing  a  parcel  post  system, 
which  amounted  to  increasing  tremendously  the  weight 
of  fourth  class  packages  that  could  be  forwarded  at  a 
given  rate.  In  the  first  zone  (50  miles)  and  the  second 
(150  miles)  the  maximum  weight  has  been  made  fifty 
pounds;  in  the  other  zones  the  maximum  is  now  twenty 
pounds.  The  rates  are  fixed  by  a  graduated  double  scale 
— one  scale  for  weight,  the  other  for  zone-distance.  A 
pair  of  scales,  a  parcel  post  map,  which  shows  the  par- 
ticular numbered  unit  of  every  post-office  in  the  United 
States,  and  a  zone,  weight,  and  rate  table  are  all  the 
equipment  a  shipper  needs  to  figure  the  cost  of  shipment. 

As  compared  with  express  shipments  it  may  be  ob- 
served that  the  latter  are  usually  lower  for  short  distances 
and  packages  weighing  only  a  few  pounds.  Express  in- 
surance may  be  made  to  cover  loss  over  fifty  dollars 
(the    parcel    post    maximum)    and    includes    protection 


TRAFFIC  503 

against  partial  loss  as  well,  a  contingency  not  provided 
for  in  the  parcel  post  system. 

Careful  comparison  of  service  rendered  as  against  rates 
charged  is  necessary  to  determine  in  many  instances 
which  is  the  more  advantageous  method.  The  choice  for 
some  commodities  will  be  in  favor  of  one,  for  others 
with  the  other;  whereas  the  difference  in  rates  for  the 
same  commodity  and  practically  the  same  service  will 
tip  the  scale  now  in  favor  of  one,  now  of  the  other. 

Correlation  of  transportation  systems. — It  is  prob- 
able that  in  the  readjustment  of  transportation  systems 
after  the  war  we  shall  see  an  intelligent  attempt,  perhaps 
fostered  by  the  Government,  at  correlation  or  co-ordina- 
tion of  the  various  transportation  systems  of  the  country. 
The  scheme  of  unification  should  include  not  only  rail- 
ways, electric  lines  and  waterways,  but  also  the  highways, 
each  system  of  transportation  not  competing  with  but 
supplementing  the  service  of  the  other.  The  scheme 
should  and  undoubtedly  will  include  not  only  the  trans- 
portation of  goods  from  place  to  place,  but  also  what  is 
called  "door  delivery."  By  this  means  each  part  of  the 
general  service  of  transportation  will  be  carried  on  by  the 
system  best  equipped  to  perform  it. 

BIBLIOGRAPHY  . 

Johnson  and  Huebner.  Railroad  Traffic  and  Rates. 
Johnson  and  Van  Metre,  Principles  of  Railroad  Transportation, 
Brown,  H.  G.,  Principles  of  Commerce. 

Lissenden,  G.  B.,  Industrial  Traffic  Management   (English). 
jMcPherson,    Logan,    Railroad    freight   Rates    in   Relation    to    the 
Industry  and  Commerce  of  the   United  States. 
Ripley,  W.  Z.,  Railroads,  Rates  and  Regulations. 
Johnson  and  Huebner,  Principles  of  Ocean  Transportation. 
Academy  of  Political  Science,  The  American  Mercantile  Marine. 
Hough,  B.  O.,  Ocean  Trade  and  traffic. 
Johnson,  E.  R.,  Ocean  and  Inland  Water  Transportation. 


•  CHAPTER    XXIII 

FOREIGN  TRADE  AND  OCEAN  TRAFFIC 

Balance  of  trade. — Before  the  European  War  the 
United  States  had  an  apparent  favorable  balance  of  trade. 
It  exported  merchandise  worth  $500,000,000  in  excess  of 
the  value  of  its  imports.  This  term  "favorable  balance  of 
trade"  dates  back  several  hundred  years  to  the  teachings 
of  the  Mercantilists,  a  school  of  economists  whose  real 
purpose  was  to  enrich  the  native  country  with  gold.  If 
exports  exceeded  imports,  the  balance  had  to  be  paid  in 
gold. 

We  now  realize  that  there  cannot  in-  normal  times  be  a 
balance  of  trade,  for  trade  must  include  not  only  merchan- 
dise, but  services  and  even  credits.  If  a  country  buys 
more  abroad  than  it  sells  abroad,  the  excess  will  have  to 
be  settled  in  one  way  or  another.  For  example,  our 
American  pre-war  "favorable  balance"  of  $500,000,000 
w^as  paid  for  as  follows : 

Interest    paid    on    American    securities    and 

property  rights  owned  abroad $175,000,000 

Freight  charges  paid  for  foreign  bottoms..       25,000,000 

Remittances  to  the  "old  country"  by  im- 
migrants          125,000,000 

Expenditures  of  American  tourists  abroad.      150,000,000 

Insurance  premiums  paid  to  foreign  com- 
panies     : 25,000,000 

Total $500,000,000 

504 


FOREIGN  TRADE  505 

These  items  include  what  are  called  the  invisible  items. 
They  are  none  the  less  real  when  it  comes  to  using  them 
for  offsetting  credit  balances. 

Present  trend  in  our  foreign  trade. — During  the  Eu- 
ropean War  the  demand  for  our  goods  raised  exports, 
while  imports  remained  fairly  stationary,  and  the  result 
was  an  increased  favorable  balance  of. trade,  paid  for 
largely  by  the  credit  of  foreign  nations  and  foreign  busi- 
ness men.  During  1919  and  the  early  part  of  1920,  im- 
ports began  to  rise  and  the  balance  diminished  somewhat. 
In  1920  and  1921  both  imports  and  exports  dropped  and 
toward  the  end  of  1921  exports  continued  to  drop  while 
imports  increased  slightly. 

Future  trend  of  foreign  trade. — There  is  due  the 
United  States  and  its  nationals  from  foreign  countries  and 
from  foreign  individuals,  annual  interest  payments  of 
somewhat  over  $600,000,000.  The  European  nations 
would  pay  this  partly  by  entertaining  the  American  tour- 
ists, by  insuring  our  cargoes  and  carrying  our  cargoes,  but 
the  balance  probably  will  not  be  struck  by  these  items  and 
we  shall  therefore  have  to  do  one  of  two  things,  either 
import  an  excess  of  commodities  or  invest  the  balance  due 
us  in  foreign  securities.  Unfortunately,  Americans  are 
provincial  in  matters  relating  to  trade,  language  and  laws, 
and  we  shall  therefore  have  to  be  educated  in  these  mat- 
ters before  American  capital  will  seek  foreign  investments.. 
However,  it  will  be  to  our  advantage  to  make  these  foreign 
investments  rather  than  to  import  merchandise.  The  prob- 
lem, then,  is  one  for  our  colleges  and  universities.  They 
must  train  men  not  only  to  have  a  smattering  knowledge 
of  the  literature  of  foreign  nations,  but  to  be  able  to  use 


5o6  PRINCIPLES  OF  BUSINESS 

foreign  languages  as  tools  of  business.  We  must  get  over 
racial  prejudices  and  must  understand,  not  in  an  academic 
.but  in  a  very  practical  way,  the  histories  of  foreign  na- 
tions. We  must  study  their  forms  of  government  and 
know  something  about  their  laws.  We  shall  then  be  ready 
to  make  investments  in  foreign  enterprises  and  in  thai 
way  help  to  keep  domestic  business  active  by  providing  the 
means  in  foreign  countries  for  paying  for  the  export  of 
our  goods. 

Nature  of  exports. — During  the  nineteenth  century  the 
United  States  yielded  to  the  world  part  of  its  natural  re- 
sources. Its  own  manufactures  were  not  largely  developed 
and  it  is  not  surprising,  therefore,  to  find  that  during  these 
early  years  most  of  our  exports  consisted  of  crude  ma- 
terials and  foodstuffs. 

The  growth  of  population  in  this  country  and  the  de- 
velopment of  our  resources  have  changed  the  situation. 
We  have  more  need  for  our  own  raw  materials  and  food- 
stuffs and  we  are  producing  an  exportable  surplus  of 
manufactured  goods.  The  story  is  told  in  the  following 
table :  ^ 

Crude  Miscel- 

Ycar*        Materials  Foodstuffs  Manufactures        laneous 

(per  cent) 

1885-1894 2,6  43  21                         t 

1895-1904 28  40  :i2                         t 

1905-1914 32  24  44                         t 

1915-1919 15  28  55                         2 

1920 25  27  48                         t 

1921 20  28  52                         t 

1922 1 26  31  43                         t 

*  Fiscal  years  ending  June. 
t  Less  than  i  per  cent. 

%  II  months  ending  May. 

*  Commerce  Monthly,  August,  1922. 


FOREIGN  TRADE  507 

During  the  early  years  our  trade  was  chiefly  with  Eu- 
rope, and  even  to-day  more  than  507c  of  our  exports  go  to 
that  continent.  However,  the  development  of  the  North 
American  continent  outside  of  the  United  States  has 
opened  up  larger  markets  for  us  on  this  side  of  the  At- 
lantic, and  our  increasing  interest  in  the  Far  East  has  re- 
sulted in  an  ever  increasing  trade  with  Asia  and  Oceania. 
In  spite  of  the  large  interest  that  has  been  taken  from 
time  to  time  in  the  development  of  South  American  trade, 
we  have  not  been  very  successful  there.  Since  1885,  as  is 
shown  in  the  annexed  table.  South  America  has  taken 
only  about  5%  of  our  exports.^ 

North  South  Asia  and 

Year*        Europe  America  America  Oceania  Africa 

1885-1894 80  II  4                     4  I 

1895-1904....       76  14  3                    5  2 

1905-1914. ...      66  20  5                    8  I 

1915-1919 67  18  5                    91 

1920 60  20  6                  12  2 

1921 53  25  8                   12  2 

1922 1 5=  24  S                   IS  I 

*  Fiscal  years  ending  June, 
t  II  months  ending  May. 

Nature  of  imports. — Before  the  European  War  our 
imports  were  chiefly  of  manufactures,  though  an  increas- 
ing percentage  was  made  up  of  crude  material,  while  a  de- 
creasing percentage  was  made  up  of  foodstuffs.  The 
shutting  down  of  European  factories  during  the  European 
War  decreased  our  imports  of  manufactures  and  in- 
creased perceptibly  the  percentage  of  crude  materials 
brought  in.     Since  the  war,  however,  we  are  getting  back 

^Commerce  Montlily,  August,  1922. 


5o8  PRINCIPLES  OF  BUSINESS 

to  the  pre-war  position,   as  is  shown  in  the  following 
table :  ^ 

Crude  Miscel- 
Ycar  *        Materials        Foodstuffs        Manufactures        laneous 

1885-1894 21                      35                         43  I 

ib9S-i904 30                     29                         41  t 

1905-1914 34                     24                         41  I 

1915-1919 40                      27                          22  I 

1920 41                      29                         29  I 

19^1 29                   .35                         35  I 

1922  % 35                     24                         40  I 


*  Fiscal  years  ending  June. 
t  Less  than  i  per  cent, 
j  II  months  ending  May. 

The  European  War  had  a  greater  effect  upon  the  di- 
rection from  which  our  imports  came,  and  while  the 
tendency  is  to  get  back  to  the  relative  positions  occupied 
before  the  war,  the  continued  upheavals  in  Europe  have 
prevented  us  from  getting  out  of  that  continent  the  pro- 
portion of  imports  that  we  used  to  get  prior  to  1914.  A 
number  of  commodities  come  directly  from  their  point 
of  origin,  and  therefore  we  find  a  large  percentage  of  our 
goods  comes  straight  from  Asia  and  Oceania.  For  ex- 
ample, while  45%  of  our  rubber  and  61  %  of  our  tin  came 
through  Europe  in  the  period  before  the  war,  now  only 
16/C  of  rubber  and  26%  of  tin  imports  enter  from  Eu- 
rope.- 

Economic  justification  of  foreign  trade. — There  are 
a  number  of  theories  concerning  foreign  trade  which  it  is 
not  necessary  for  us  to  introduce  here.  Most  of  them  have 
some  element  of  truth  in  them.  Some  people,  for  ex- 
ample, feel  that  foreign  trade  is  a  logical  development  of 

^Commerce  Monthly,  August,  1922. 
"■Ibid. 


FOREIGN  TRADE  509 

the  principle  of  the  division  of  labor.  Nations  produce 
what  they  are  best  qualified  to  produce  and  therefore  must 
rely  upon  outside  nations  for  other  commodities.  Peace  is 
promoted  in  this  way  for  the  economic  organization  that 
is  built  up  is  very  delicate. 

Foreign  trade  acts  as  a  sort  of  governor  and  enables 
domestic  producers  to  extend  their  markets  and  be  free 
from  local  disturbances.  The  importance  of  a  stable 
amount  of  business  is  sometimes  not  appreciated  by  busi- 
ness men.  It  rests  upon  the  theory  of  fixed  and  variable 
costs.  If,  for  example,  a  business  produces  $1,000,000, 
with  operating  expenses  of  $600,000,  of  which  40 ^f  are 
fixed  and  6o9c  variable,  a  drop  of  10%  in  gross  business 
will  amount  to  a  drop  of  16%  in  profits  as  follows  : 

Normal  Year  Decrease  of  10%  Decrease  of  30% 

in  Gross  in  Gross 

Gross  Revenue    $1,000,000  $900,000  $800,000 

Operating  Expenses .  .        600,000  564,000  *  528,000 


Profits    $    400,000  $336,000  $272,000 


*6o%   of   the  $600,000  will   drop   io9c,  i.e.,   io9e   of  $360,000,  or 
$36,000. 

The  decrease  of  $64,000  in  profits  is  a  decrease  of  16% 
and  the  decrease  of  $128,000  is  a  decrease  of  3290.  It 
appears  therefore  that  a  decrease  in  gross  revenues  is  re- 
flected by  a  decrease  in  profits  twice  as  great.  Under  these 
circumstances  it  will  pay  a  manufacturer  to  find  an  outlet 
for  his  maximum  production  even  if  the  last  products  are 
sent  to  foreign  countries  at  prices  considerably  reduced. 
It  affects  adversely  the  business  of  the  country  where  the 
dumping  takes  place,  and  some  countries  therefore  have 
passed  laws  forbidding  the  practice.^ 

^  See  Kidd's  Foreign  Trade,  p.  24  et  seq. 


510  PRINCIPLES  OF  BUSINESS 

Developing  foreign  markets. — A  business  that  wishes 
to  enter  foreign  trade  must  first  find  out  where  a  possible 
demand  for  its  product  exists,  the  extent  of  the  demand, 
pecuHar  quahties  of  the  demand  depending,  for  example, 
on  racial  prejudices  or  local  custom,  the  best  methods  of 
reaching  the  market,  whether,  for  example,  through 
branch  houses,  local  agents  or  the  like,  and  the  problems 
involved  in  shipping  and  financing. 

A  market  analysis  therefore  of  a  foreign  country  would 
include  a  study  of  purchasing  power  and  prices,  special 
conditions  of  demand  peculiar  to  the  market,  buying  sea 
sons,  location  of  lists  of  possible  buyers,  influence  of 
other  nations  in  controlling  the  market,  and  national  or 
racial  prejudice. 

Purchasing  power. — A  fair  example  of  what  is  meant 
by  understanding  the  purchasing  power  is  supplied  by 
these  figures  concerning  Algeria.  The  statement  that 
Algeria  contains  5,802,464  people  is  altogether  misleading, 
since  an  analysis  of  the  population  shows  that  4,971,424 
are  natives. 

Special  marketing  conditions. — The  likes  and  dis- 
likes of  people  frequently  are  more  important  than  the 
intrinsic  quality  of  the  product.  Habit  is  a  powerful 
force  which  is  usually  easier  to  enlist  as  an  ally  than  to 
overcome  as  an  obstacle.  The  International  Harvester 
Co.,  for  example,  in  building  machines  for  Great  Britain, 
discovered  that  gates  in  the  stone  walls  were  built  of  a 
standard  width,  too  narrow  to  accommodate  their  ma- 
chines. To  change  the  gates  would  have  been  sacrilege, 
and  therefore  the  machines  had  to  be  constructed  to  run 
sideways  for  the  purpose  of  getting  them  into  the  fields. 


FOREIGN  TRADE  511 

Buyers. — The  same  waste  of  misdirected  advertising 
will  be  experienced  in  foreign  countries  as  is  experienced 
at  home  unless  some  effort  is  made  to  get  directly  to  poten- 
tial buyers.  Various  agencies  exist  in  this  country  for 
securing  names  of  wholesalers  and  retailers  in  various 
lines.  The  Department  of  Commerce  can  assist  in  mak- 
ing this  part  of  the  investigation. 

Sources  of  information. — The  chief  problem  in  market 
analysis  is  to  discover  sources  of  information.  The  rest 
is  a  matter  of  diligence  and  carefulness.  Various  agencies 
in  the  United  States  such  as  the  large  banks,  the  Foreign 
Trade  Council,  the  Philadelphia  Museum,  foreign  Ameri- 
can chambers  of  commerce,  the  National  Association  of 
Manufacturers,  and  especially  the  Bureau  of  Foreign  and 
Domestic  Commerce  of  the  Department  of  Commerce,  will 
generally  yield  all  the  material  necessary  to  supply  the 
needed  information.^     The  number  of  trade  lists  of  for- 

^  The  following  is  a  list  of  the  foreign  Chambers  of  Commerce 
in  America : 

American-Russian    Chamber   of    Commerce,   2;^;^    Broadway,    Xew 

York  City. 
American-Roumanian  Chamber  of   Commerce,  Room  872,   Wool- 
worth   Building,   New  York  City. 
American-Polish  Chamber  of  Commerce  and  Industry  of  the  U.  S., 

40  W.  40th  St.,  New  York  City. 
Argentine-American  Chamber  of   Commerce,  64  Broad  St.,   Ne\Y 

York  City. 
Belgian  Chamber  of  Commerce,  59  Pearl  St.,  New  York  City. 
British  Chamber  of  Commerce,  295  Broadway,  New  York  City. 
Chinese  Chamber  of   Commerce,  701   Grant  Ave.,   San   Francisco, 

Cal. 
Czechoslovak  Chamber  of  Commerce  in  America,  60  South  Water 

St.,  Chicago,  111. 
Czechoslovak  Chamber  of  Commerce,  106  E.  19th  St.,  New  York 

City. 
Franco- American  Board  of  Commerce  and  Industry,  Room   17 19, 

Flatiron  Building,  New  York  City. 
French  Chamber  of   Commerce  of   New  York,  456  Fourth  Ave., 

New  York  City. 


512  PRINCIPLES  OF  BUSINESS 

eign  merchants  furnished  by  the  Department  of  Foreign 
Commerce  for  a  period  of  four  weeks  shows  the  follow- 
ing totals :  ^ 

February  ii,  1922 768 

February  18,  1922 135 1 

February  25,  1922 1 158 

March  4,  1922 1 1 15 

Mediums  for  reaching  foreign  markets. — While  the 
same  paraphernalia  in  general  may  be  used  in  foreign 
countries  as  is  used  in  this  country,  attention  must  of 
course  be  given  to  local  custom.  The  aim  generally  should 
be  to  give  a  local  flavor  to  whatever  medium  is  used.  For 
example,  it  is  doubtful  if  any  kind  of  a  circular  could  be 
printed  in  Germany  with  the  presses  and  type  they  use 
there  that  would  not  be  detected  as  a  German  product  im- 
mediately by  the  average,  intelligent  business  man.     If 

Holland-American  Chamber  of  Commerce  for  the  Pacific  Coast 
States,  Inc.,  235  Montgomery  St.,  San  Francisco,  Cal. 

Italian  Chamber  of  Commerce,  604  Montgomery  St.,  San  Fran- 
cisco, Cal. 

Italian  Chamber  of  Commerce,  1613  Masonic  Temple,  Chicago,  111. 

Italian  Chamber  of  Commerce  in  New  York,  99  Hudson  St.,  New 
York  City. 

Japanese  Chamber  of  Commerce,  444  Rush  St.,  San  Francisco,  Cal. 

Norwegian-American  Chamber  of  Commerce,  17  State  St.,  New 
York  City. 

New  York  Chamber  of  Commerce  for  the  Netherlands  and  the 
Netherlands  East  and  West  Indies,  Inc.,  Room  9s6,  11  Broad- 
way, New  York  City. 

Pan-American  Chamber  of  Commerce,  42  Broadway,  New  York 
City. 

Philippine-American  Chamber  of  Commerce,  27  Broadway,  New 
York  City. 

Portuguese  Chamber  of  Commerce  and  Industry  in  New  York, 
29  Broadway,  New  York  City. 

Spanish  Chamber  of  Commerce  in  New  York,  129  Water  St., 
New  York  City. 

Swedish  Chamber  of  Commerce,  Produce  E.xchange  Annex,  New 
York  City. 

^  Ninth  National  Foreign  Trade  Convention,  p.  294. 


FOREIGN  TRADE  513 

that  holds  true  of  German  literature  in  America,  the  same 
probably  holds  true  of  American-produced  literature  used 
in  other  countries.  Translations  should  be  made  by  na- 
tives who  understand  the  idioms.  The  best-educated  col- 
lege professor  would  probably  turn  out  a  ridiculous  cir- 
cular or  catalogue.  Export  catalogues,  house  organs,  for- 
eign newspapers,  display  rooms  and  moving  pictures  have 
all  been  used  with  good  results  by  leading  American  ex- 
porting houses,  and  many  have  found  that  participation  in 
foreign  affairs  is  a  helpful  form  of  publicity.  It  may  be 
noted  in  passing  that  the  trade-mark  generally  plays  a  more 
important  part  in  foreign  commerce  than  it  does  in  Ameri- 
can commerce.  For  example,  the  foreign  company  desir- 
ing to  register  a  local  brand  in  China  is  required  by  law 
to  give  not  only  its  name  but  its  trade-mark.  The  prob- 
lem of  protecting  established  trade-marks  from  piracy  by 
native  merchants  in  some  countries  becomes  a  very  serious 
one. 

The  packing  problem. — When  American  exporters 
were  beginning  to  enter  foreign  fields,  they  made  the  mis- 
take of  paying  little  attention  to  the  problem  of  properly 
packing  their  goods.  The  result  was  that  goods  were 
damaged,  lost,  or  stolen,  so  that  the  consignee — and  some- 
times the  consignor,  where  he  was  to  pay  freight  and 
tariff — lost  all  possible  profits  through  neglect  to  pack 
economically.  For  example,  where  the  tariff  is  laid  by 
weight  on  the  gross  burden  of  container  and  goods,  it 
would  be  the  lieight  of  folly  to  ship  in  heavy  metal  cases 
if  the  goods  could  be  packed  in  boxes  or  bales.  Where 
goods  are  to  be  transship])ed,  they  must  necessarily  re- 
ceive extra  care,  and  some  thought  must  be  given  to  the 


514  PRINCIPLES  OF  BUSINESS 

mechanical  means  used  in  handling  the  packages;  other- 
wise goods  will  be  destroyed  by  hooks  or  smashed  in 
chutes.  If  the  country  to  which  goods  are  consigned  is 
noted  for  excessive  heat  or  dampness,  some  measures 
should  be  provided  for  these  exigencies.  Moreover,  the 
legal  rules  for  marking  packages  to  meet  tariff  regulations 
should  be  observed.  These  usually  require  a  statement  of 
gross  weight  and  net  weight,  that  is,  a  statement  of  the 
weight  of  the  entire  package  and  a  statement  of  the  pack- 
age less  the  tare. 

On  the  subject  of  "Lessons  of  the  Past  Year,"  Sir 
Stanley  G.  Flagg,  Jr.,  of  Stanley  G.  Flagg  &  Co.,  Phila- 
delphia, made  these  remarks  concerning  the  special  topic 
of  "packing"  at  the  Ninth  National  Foreign  Trade  Con- 
vention. "We  know  that  goods  carriages  abroad  are  usu- 
ally shorter  than  our  own,  that  tonnage  capacities  are 
usually  much  less,  that  with  them  a  carload  may  mean  8 
tons,  and  with  us  from  35  to  50  tons.  We  have  learned 
that  facilities  for  loading  and  unloading,  with  or  without 
tackle,  are  limited  as  to  capacity,  and  that  land  transpor- 
tation has  many  and  frequent  restrictions.  Perhaps  we 
overlook  special  packing  construction  as  affecting  custom- 
ers' needs,  which,  in  many  cases,  if  not  adhered  to,  will 
cause  costly  outlays,  for  which  we  may  be  held  respon- 
sible if  we  failed  to  be  exact  in  carrying  out  these  instruc- 
tions by  our  customers.  We  have  found  that  duties  are 
assessed  by  weight  and  that  these  duties  most  frequently 
are  assessed  upon  the  weight  of  the  container  as  well.  The 
legend,  'handle  with  care,'  means  little  where  no  English 
is  spoken,  and  we  know  that  'fragile'  is  much  better  to  use, 
inside  or  outside  of  English  speaking  countries.    We  have 


FOREIGN  TRADE  $15 

also  found  that  provisions  for  the  proper  use  of  hooks  and 
hfting  tackle  are  not  without  value." 

In  selling  goods  to  foreign  countries,  an  important  item 
of  cost  is  the  transportation  tariff.  Losses,  special  fees 
and  taxes,  costs  of  handling,  and  other  items,  also  add  to 
the  cost  of  laying  down  goods  in  a  foreign  country.  It 
therefore  becomes  very  necessary  in  making  a  contract  to 
understand  which  of  the  parties  is  to  bear  these  costs. 
The  settlement  of  this  question  depends  almost  entirely 
upon  the  method  of  quotation.  Nine  quotations  are  in 
more  or  less  common  use,  the  meaning  of  which  have  been 
fairly  well  established.  These  quotations  and  their  inter- 
pretations are  as  follows  :  ^ 


F.  O.  B.   (free  on  board)    shipping  point. 

F.  O.  B.   (named  point)    freight  prepaid  to  seaport. 

F.  O.  B.   (named  point)    freight  allowed  to  seaport. 

F.  O.  B.  cars   (named  port  on  seaboard). 

F.  O.  B.  cars   (named  port)   lighterage  free. 

F.  O.  B.  vessel   (port  named). 

F..A.  S.   (free  along  side)    (port  named). 

C.  I.  F.  (cost,  insurance,  freight)  foreign  port  named. 

C.  and  F.  (cost  and  freight)  named  foreign  port. 


Of  all  these  quotations,  the  one  most  frequently  used 
and  the  one  that  is  generally  regarded  as  the  most  effi- 
cient is  the  C.  I.  F.  quotation. - 

Documentation. — One  who  desires  to  understand  the 
workings  of  foreign  trade  must  very  early  in  his  studies 
take  up  the  problem  of  the  papers  that  are  used  in  con- 
nection with  the  carriage,  insurance,  and  financing  of  ship- 
ments.    Besides  the  shipping  permit  which  enables  the 

^  For  the  exact  meaning  of  these  terms,  see  Kidd's  Foreign  Trade, 
Chapter  VIII. 

^  For  a  very  concrete  discussion  of  the  advantages  of  quoting  on 
various  bases,  see  Official  Proceedings,  Ninth  National  Foreign  Trade 
Convention,  pp.  i68  et  seq. 


5i6  PRINCIPLES  OF  BUSINESS 

consignor  to  deliver  the  goods  at  the  wharf,  and  which  is 
obtained  from  either  the  railroad  delivering  to  the  ship- 
ping company  or  from  the  shipping  company  direct,  there 
are  the  following  documents  to  be  considered:  the  bill  of 
lading,  the  bill  of  exchange,  the  invoice,  and  the  marine  in- 
surance certificate.  All  of  these  documents  taken  together 
constitute  the  "documentary  bill." 

The  bill  of  lading  may  be  a  bill  for  the  railroad,  with 
another  for  the  ship,  or  it  may  be  a  through  bill  carrying 
the  goods  from  the  point  of  shipment  to  the  foreign  coun- 
try. Bills  of  lading  must  be  carefully  studied  for  if  they 
throw  any  suspicion  on  the  title  to  the  goods,  or  on  their 
condition,  or  leave  room  for  dispute  as  to  responsibility 
for  damage,  difficulty  will  be  experienced  in  financing  the 
shipment.  The  American  law  governing  carriers'  liability 
is  the  so-called  Harter  Act  of  1893,  which  provides  in 
part  that  a  shipping  company  cannot  insert  a  clause  in  its 
bill  of  lading  absolving  itself  from  liability  for  negligence. 
A  movement  is  now  on  foot  to  have  adopted  in  the  impor- 
tant trade  countries  of  the  world,  as  a  uniform  law,  certain 
rules  drafted  by  the  Maritime  Law  Committee  of  the  In- 
ternational Law  Association.  These  rules  are  known  as 
the  Hague  Rules  and  are  very  similar  to  those  laid  down 
in  our  own  Harter  Act,  with  three  important  additions : 
they  increase  the  carrier's  liability  from  the  now  usual 
$100  per  package  to  £100;  they  allow  twelve  months  in 
which  the  shipper  may  make  claims  for  damage  (the  bills 
of  lading  now  in  general  use  provide  that  claims  must  be 
made  before  removal  of  the  goods  from  the  wharf),;  they 
shift  the  burden  of  proof  in  cases  of  loss  from  the  shipper 
to  the  carrier.     These  rules  are  actually  in  use  by  ships 


FOREIGN  TRADE  517 

of  the  great  Atlantic  lines  moving  goods  to  Europe,  but 
they  have  not  yet  been  adopted  in  this  country. 

Kinds  of  bills  of  lading. — Bills  of  lading  are  issued  in 
series,  the  number  depending  on  the  number  of  people 
concerned  with  the  shipment.  Non-negotiable  copies  are 
furnished  for  the  files  of  the  shipper,  the  shipping  com- 
pany, the  consular's  office  and  the  bank,  and  negotiable 
copies  are  furnished  for  transferring  ownership  by  en- 
dorsement. 

"Clean  bills"  are  those  which  indicate  that  the  carrier 
has  received  the  goods  in  sound  condition.  "Straight 
bills"  are  those  which  are  used  when  the  goods  have  been 
paid  for  or  have  been  sold  on  open  account,  or  when  the 
law  of  the  foreign  country  requires  it.  They  will  not  be 
honored  except  when  presented  by  the  consignee  or  his 
agent.  "Order  bills"  are  most  frequently  used,  and  read, 
as  far  as  right  to  receive  the  goods  is  concerned,  "Re- 
ceived from  exporter,  to  be  delivered  at  port  (of  destina- 
tion) unto  order,  or  to  his  or  their  assigns." 

Marine  insurance. — With  the  exception  of  the  pro- 
vision contained  in  the  Harter  Act,  which,  as  we  have 
seen,  does  not  permit  a  carrier  to  excuse  its  own  negli- 
gence, the  typical  bill  of  lading  is  usually  carefully  drawn 
to  avoid  liabilities  that  might  in  the  absence  of  such  a 
contract  be  visited  on  the  shipping  company.  The  shipper, 
therefore,  must  protect  himself  by  insurance.  Thus,  un- 
der the  principle  of  "general  average,"  if  any  goods  are 
thrown  overboard  to  save  the  ship  and  its  cargo,  the 
company  and  the  cargo  owners  must  contribute  to  save 
the  owner  of  the  jettisoned  goods  from  total  loss.  In- 
surance policies,  like  the  bills  of  lading,  must  be  carefullv 


5i8  PRINCIPLES  OF  BUSINESS 

studied,  for  the  insurance  companies  will  issue  policies 
that  cover  only  the  perils  of  the  sea,  containing,  of  course, 
clauses  that  protect  against  other  perils  such  as  fire,  theft, 
leakage,  breakage  and  the  like. 

The  invoices. — The  invoice  in  a  foreign  shipment  is 
a  much  more  important  document  than  it  is  in  domestic 
trade,  for  it  describes  exactly,  or  should  describe  ex- 
actly, the  goods  and  their  value  for  financing  purposes  and 
as  a  basis  of  customs  assessment  in  foreign  countries. 
Two  copies  are  used,  one  called  the  commercial  invoice, 
and  the  other  the  consular  invoice  in  which  the  particulars 
are  certified  to  by  the  consul  of  the  foreign  country  to 
which  the  goods  are  directed. 

Other  papers. — Other  papers  are  used  in  foreign  trade 
work.  Some  countries  require  certificates  of  origin  and 
non-dumping  certificates.  Dock  receipts  are  instruments 
given  for  delivery  of  goods  at  the  carrier's  wharf,  and 
are  to  be  exchanged  later  for  bills  of  lading.  Under 
the  dock  receipt  the  carrier  is  a  mere  bailee  and  not  a 
carrier.  The  drawback  is  a  paper  which  entitles  the 
shipper  to  99  per  cent  of  the  tariff  duty  on  certain  ma- 
terials used  in  the  goods  that  are  being  exported.  In 
effect,  it  provides  that  the  materials  used  to  make  the 
exported  goods  were  only  temporarily  held  in  the  coun- 
try and  therefore  should  not  have  paid  the  customs  duty 
in  the  first  place. 

Parcel  receipts  are  used  for  small  parcels  such  as  sam- 
ples that  are  carried  separately  and  can  be  released 
promptly  on  the  arrival  of  the  ship. 

A  packing  list  is  sometimes  sent  to  show  the  foreign 
importer  how  the  goods  will  arrive  and  how  they  must  be 


FOREIGN  TRADE  519 

handled.  This  is  sometimes  supplemented  by  the  state- 
ment of  charj^es  which  shows,  besides  the  value  of  the 
goods,  the  individual  items  of  cost  of  shipping. 

Ocean  traffic. — One  who  wishes  to  understand  the 
workings  of  foreign  trade  must  have  some  appreciation 
of  the  problems  of  ocean  traffic.  While  our  discussion 
cannot  be  exhaustive,  it  will  pay  to  consider  briefly  some 
of  the  more  important  factors,  such  as  trade  routes,  types 
of  vessels,  ports,  rates  and  practices. 

Trade  routes. — The  principal  trade  routes  of  the 
world,  as  defined  at  greater  length  by  Mr.  B.  Olney 
Hough,  in  his  Ocean  Traffic  and  Trade,  are  the  following : 

1.  The  North  Atlantic  Route — between  North  America 
and  Northern  Europe.  Practically  the  same  route  is 
taken  by  vessels  plying  from  North  America  and  Europe 
to  West  Indian  and  Central  American  ports. 

2.  The  Mediterranean  and  Oriental  Route — between 
the  United  States  or  Northern  Europe  and  the  Mediter- 
ranean, Southern  Europe,  Northern  Africa,  India,  the 
Straits  Settlements,  the  Philippines,  Japan  and  Australasia. 

3.  The  South  African  Route — between  American  or 
European  ports  and  Cape  Town,  Port  Elizabeth,  East 
London,  Durban  and  Delagoa  Bay. 

4.  The  South  American  Route — between  Europe  or  the 
United  States  and  the  east  and  west  coasts  of  South 
America. 

5.  The  Caribbean  Route — between  Europe  or  the 
United  States  and  the  ports  of  the  Caribbean  and  the 
Gulf  of  Mexico,  including  American  ports  on  the  Gulf. 

6.  The  East  Asia-American  Route — the  Pacific  Route 
between  North  America  and  Asia. 


520  PRINCIPLES  OF  BUSINESS 

7.  The  North  and  South  Pacific  Route — between  the 
North  American  Pacific  Coast  and  Australasian  Colonies. 

The  various  trade  routes,  of  course,  are  served  by  sub- 
sidiary routes  or  "feeders."  Not  all  vessels  go  and  come 
over  the  same  routes — in  some  cases  a  triangular  course 
is  necessary,  as  from  the  United  States  to  Brazil,  Brazil 
to  England,  and  England  to  the  United  States.^ 

Types  of  vessels. — Ocean  carriers  may  be  classified 
generally  as  being  freighters,  passenger  vessels,  and  vessels' 
which  carry  both  freight  and  passengers.  Freighters  may 
be  either  "liners"  or  "tramps,"  a  liner  being  a  vessel  which 
has  a  regular  route  and  a  regular  time  of  arrival  and  de- 
parture. The  greater  part  of  the  world's  ocean  freight  is 
carried  by  "tramp  steamers,"  which  may  be  chartered  for 
voyages  to  any  part  of  the  world. 

Ships  may  be  steel;  composite  (steel  frame  and  wood 
covering)  ;  wood ;  or  concrete.  The  concrete  ship  is  a  late 
development,  the  outcome  of  which  is  still  in  doubt. 

The  relative  importance  of  these  types  is  shown  in  the 
following  table,  taken  from  Riegel's  Merchant  Vessels. 

CONSTRUCTION  MATERIAL 
World's  Merchant  Marine^ 

Wood  Iron  Steel 

1890  7,053,885  10,517,513  4,435-208 

189s  5,534,677  9,211,561  10,223,101 

1900  4,009,622  7,398,102  17,508,704 

1905  3,394.850  6,044,824  26,445,998 

1910 2,544,858  4,548,509  34,728,700 

191 1  2,409,331  4,233,858  36,1 16,427 

1912  2,270,558  3,981,056  38,263,659 

1913  2,113,276  3,721,285  41,005,887 


^  The  Shipping  Board  has  inaugurated  many  new  routes,  several 
leading  directly  to  South  America.  See  map  in  Zimmermann's  Ocean 
Shipping,  p.  59. 

^  Comm.  Nav.  Report,  igi/,  p.  66. 


Iron 

Steel 

3,529,097 

3,353,146 
3-154,091 
2,294,410 

43,465,210 
43,112.311 
43,596,761 
45,111,284 

FOREIGN  TRADE  521 

Wood 

1914 1,983,458 

1915  1,920,264 

1916  1,856,176 

1919 3,513,579 

Motive  power. — The  day  of  the  saihng  vessel  is  not 
yet  gone.  Internal  combustion  engines,  such  as  are  used 
in  automobiles,  but  adapted,  of  course,  to  marine  use,  and 
Diesel  engines,  used  as  auxiliaries,  will  probably  prolong 
the  life  of  sailing  vessels,  for  the  winds  furnish,  under 
favorable  conditions,  a  cheap  and  effective  means  of  pro- 
pulsion. Steam  vessels  are  still  largely  in  the  majority, 
but  a  better  understanding  of  the  advantages  of  the  Diesel 
engine  will  probably  cause  its  substitution  quite  generally 
for  the  steam  prime  mover. ^  The  use  of  oil  under  steam 
generating  boilers,  instead  of  coal,  and  its  use  in  Diesel 
engines  is  causing  a  world-wide  scramble  for  oil,  that 
may  for  years  precipitate  international  political  jealousies. - 

Computation  of  tonnage. —  The  term,  tonnage,  used 
with  respect  to  ships,  refers  to  their  carrying  capacity. 
Several  "tons"  are  used  as  bases  of  computation.  A 
"ton"  in  ocean  transportation  is  usually  a  long  ton  (2,240 
pounds),  but  in  the  coastwise  traffic  of  the  United  States 
the  short  ton  (2,000  pounds)  is  commonly  employed.  On 
the  continent  of  Europe  the  metric  ton  (2,205  pounds) 
is  often  used. 

Displacement  tonnage.  The  displacement  tonnage  of  a 
vessel  is  the  weight  of  the  vessel  in  long  tons,  when  fully 

^  A.  Diesel  engine  is  an  engine  that  generates  power  by  exploding 
a  low-grade  oil  under  great  pressure— so  great  that  the  heat  does  the 
exploding,  whereas  in  the  gasoline  engine  an  electric  spark  is  usually 
relied  upon  to  cause  the  explosion. 

^  See  Zimmermann's  Ocean  Shipping,  Chapter  X. 


522  PRINCIPLES  OF  BUSINESS 

loaded.  This  is  equivalent  to  the  weight  of  the  water  dis- 
placed by  the  vessel,  a  cubic  foot  of  sea  water  being  esti- 
mated to  weigh  35  pounds.  This  term  is  used  principally 
with  respect  to  ships  of  war. 

Dead-weight  capacity.  The  dead-weight  capacity  of  a 
vessel  is  the  number  of  long  tons  it  can  carry  when 
loaded  to  its  maximum  depth,  this  depth  being  indicated, 
on  British  vessels,  by  a  line  called  the  Plimsoll  line. 

Gross  and  net  tonnage.  The  gross  tonnage  of  a  vessel 
is  its  total  capacity  in  cubic  feet  divided  by  lOO — so  that 
a  ship  measures  one  gross  ton  for  each  lOO  cubic  feet  of  its 
total  carrying  space.  Since  much  of  this  total  space, 
being  taken  up  by  machinery  and  other  fixtures,  is  un- 
available for  the  reception  of  passengers  or  freight,  the 
space  which  is  available  for  this  purpose  must  be  measured 
separately,  and  is  called  the  net  tonnage,  the  basis  being 
the  same — lOO  cubic  feet  being  estimated  as  a, ton.  The 
usual  ratio  of  net  tonnage  to  gross  tonnage  is  about  two 
to  three;  that  is,  two-thirds  of  the  total  carrying  space  in 
ton-units  of  lOO  cubic  feet  is  net  tonnage. 

Registered  tonnage  is  the  gross  or  net  tonnage  specified 
in  the  description  of  the  ship  when  it  is  registered — regis- 
tration being  the  submitting  of  a  sworn  statement  of 
ownership,  specifications,  and  other  data  to  the  proper 
authority,  usually  the  collector  of  the  port,  whereupon,  if 
all  requirements  have  been  complied  with,  a  certificate  of 
registration  is  issued,  entithng  the  vessel  to  the  privileges 
and  protection  of  the  government  under  which  it  is  reg- 
istered. 

Cargo  or  measurement  tonnage.  The  basis  upon  which 
a  carg:o  is  taken  on  is  either  the  "measurement  ton"  of 


■      FOREIGN  TRADE  523 

40  cubic  feet,  or  the  weight  ton,  whichever  will  result  in 
the  largest  profit  to  the  owners  of  the  vessel.  Commodi- 
ties vary  in  the  relation  of  their  weight  to  their  bulk;  the 
measurement  ton  of  40  cubic  feet  is  designed  as  being  rep- 
resentative of  the  space  occupied  by  a  weight  ton  of  aver- 
age commodities. 

Ocean  freight  rates. — Ocean  transportation  is  the 
cheapest  form  of  transportation,  on  the  basis  of  the  cost 
of  moving  a  certain  quantity  of  goods  a  given  distance. 
The  reasons  for  the  cheapness  of  ocean  freight  rates  are 
that  a  great  bulk  of  goods  can  be  carried  at  once,  and 
that  there  is  no  cost  of  construction  or  upkeep  of  road-bed 
as  there  is  in  the  case  of  a  railroad,  the  only  costs  attach- 
ing being  those  of  the  ships  and  of  the  terminal  facilities, 
together  with  the  operating  expenses.  Rates  do  not  vary 
greatly  with  the  distance,  since  the  greatest  cost  is  incurred 
at  the  terminals.  While  ocean  rates  have  not  been  stabil- 
ized to  the  extent  to  which  railroad  rates  have  been,  a 
fair  degree  of  uniformity  has  been  secured  by  means  of 
agreements  or  "conferences"  between  the  owners  of 
"liners."  The  rates  charged  by  liners  in  normal  times 
are  "what  the  traffic  will  bear,"  due  consideration  being 
given  to  the  possibility  of  the  competition  of  tramp  steam- 
ers, whose  charter  rates  are  determined  entirely  by  com- 
petition and  are  fixed  on  the  shipping  exchanges,  where 
their  services  are  sold  by  brokers.  The  brokers  handling 
this  class  of  business  are  in  constant  telegraphic  and  cable 
communication  with  shippers  and  owners  of  tramp  ves- 
sels in  all  parts  of  the  world. 

The  United  States  Shipping  Act  of  September  7,  191 6, 
while   permitting   conference   agreements,    provides   that 


524  PRINCIPLES  OF  BUSINESS 

such  agreement  must  be  submitted  to  the  Shipping  Board. 
The  Act,  however,  forbids  rebates,  preferences  and  all 
other  forms  of  discrimination  between  American  shippers. 
The  Merchant  Marine  Act  of  1920. — The  Jones  Act 
of  1920  has  for  its  purpose  the  building  up  of  an  Ameri- 
can merchant  marine.  During  the  Revolution  our  mer- 
chant marine  fell  away  sadly,  but  just  prior  to  the  Civil 
War  our  "clippers"  "dominated  the  commerce  of  the 
world.'"  ^  By  1910  our  shipping  again  was  in  a  bad  way; 
only  10  per  cent  of  our  imports  and  7^  per  cent  of  our 
exports  were  carried  under  our  own  flag.  The  determina- 
tion of  the  iVmerican  Government  to  remedy  this  situation 
is  voiced  in  the  preamble  to  the  Jones  Act :  "It  is  neces- 
sary for  the  national  defense  and  for  the  proper  growth 
of  its  foreign  and  domestic  commerce  that  the  United 
States  shall  have  a  merchant  marine  of  the  best  equipped 
and  most  suitable  types  of  vessels  sufficient  to  carry  the 
greater  portion  of  its  commerce  and  serve  as  a  naval  or 
military  auxiliary  in  time  of  war  or  national  emergency, 
ultimately  to  be  owned  and  operated  privately  by  citizens 
of  the  United  States;  and  it  is  hereby  declared  to  be  the 
policy  of  the  United  States  to  do  whatever  may  be  neces- 
sary to  develop  and  encourage  the  maintenance  of  such  a 
merchant  marine,  and,  in  so  far  as  may  not  be  inconsistent 
with  the  express  provisions  of  this  Act,  the  United  States 
Shipping  Board  shall,  in  the  disposition  of  vessels  and 
shipping  property  as  hereinafter  provided,  in  the  making 
of  rules  and  regulations,  and  in  the  administration  of  the 
shipping  laws,  keep  always  in  view  this  purpose  and  object 
as  the  primary  end  to  be  attained." 

*  William  Brown  Meloney's  Heritage  of  Tyre,  p.  89. 


FOREIGN  TRADE  525 

The  Act  has  been  well  summarized  in  a  pamphlet  issued 
by  the  Mechanics  and  Metals  National  Bank  of  New  York, 
from  which  the  liberty  has  been  taken  of  making  the  fol- 
lowing extracts;  "The  provisions  of  the  Jones  Bill  may 
be  divided,  for  purposes  of  a  brief  summary,  into  four 
classifications  :  ( i  )  specific  enactments  governing  the  com- 
position of  the  Board  and  assistance  to  shipping;  (2) 
regulatory  provisions;  (3)  instructions  covering  liquida- 
tion of  government  holdings;  and  (4)  investigations  di- 
rected to  be  made. 

"(i)  The  Act  repeals  war  emergency  legislation  and 
three  sections  of  the  1916  Act,  and  amends  other  sections 
of  it;  it  sets  up  a  board  of  seven  (instead  of  five)  com- 
missioners, territorially  and  politically  representative,  with 
salaries  of  $12,000  (previously  $7,500),  to  direct  and  en- 
force its  provisions  and  to  exercise  powers  previously 
granted  to,  and  delegated  by,  the  President.  It  directs  the 
President  to  terminate  those  provisions  of  treaties  with 
other  countries  which  restrict  the  right  of  the  United 
States  to  impose  discriminating  customs  duties  favoring 
imports  in  United  States  vessels  and  discriminating  ton- 
nage dues.  Profits  of  ship  operation  [are  relieved  from] 
Federal  war  and  excess  profits  taxes  if  an  amount  equal 
to  these  taxes  is  invested  in  new  ship  construction  in 
United  States  shipyards,  up-  to  one-third  of  the  cost  of 
the  new  construction:  similarly,  it  [the  Act]  exempts 
from  these  taxes  profits  from  ship  sales  if  the  entire  profits 
are  invested  in  new  ship  construction.  These  exemptions 
apply  for  a  period  of  ten  years  beginning  with  1921. 

"The  Board  may  create  separate  insurance  funds  to 
insure  its  own  interests  in  vessels  or  plants ;  and  a  revolv- 


526  PRINCIPLES  OF  BUSINESS 

ing  construction  loan  fund  out  of  revenues  during  five 
years  not  exceeding  $25,000,000  to  aid  in  the  construc- 
tion of  ship  tonnage  in  private  yards,  up  to  two-thirds  of 
the  cost  of  each  vessel. 

"The  Board  is  directed  to  take  over,  maintain,  and  de- 
velop dock  and  terminal  properties  acquired  by  the  Presi- 
dent, these  not  to  be  sold  unless  authorized  by  law. 

"Considered  of  fundamental  importance  in  its  bearing 
on  the  whole  shipping  problem,  inasmuch  as  the  liquidation 
of  government  tonnage  is  dependent  upon  the  investment 
of  private  funds,  is  Section  30  of  the  IMerchant  Marine 
Act,  1920,  cited  for  separate  reference  as  the  Ship  Mort- 
gage Act,  1920.  This  section  specifically  and  in  great  de- 
tail changes  the  existing  law  of  ship  mortgages  to  allow 
the  granting  of  a  preferred  mortgage  to  take  precedence 
over  all  maritime  liens.  By  thus  improving  the  security 
afforded  for  ship  mortgages,  it  is  expected  that  a  greater 
amount  of  money  will,  other  things  being  equal,  be  at- 
tracted to  investment  in  American  shipping. 

"(2)  Section  28  prohibits  the  application  of  lowered 
joint  or  proportional  rates  by  carriers  subject  to  the  Inter- 
state Commerce  Act  in  connection  with  foreign  transpor- 
tation except  in  conjunction  with  vessels  documented  un- 
der United  States  laws.  The  Interstate  Commerce  Com- 
mission may,  however,  suspend  the  application  of  this  sec- 
tion, where  in  the  opinion  of  the  Shipping  Board,  ade- 
quate facilities  are  not  provided  by  American  vessels. 
This  discrimination  in  favor  of  our  shipjiing  is  another 
example  of  the  advantages  sought  to  be  gained  for  the 
American  merchant  marine  by  this  shipping  legislation, 
without  a  resort  to  measures  of  direct  subsidy,  both  cham- 


FOREIGN  TRADE  527 

pioned  and  opposed  so  bitterly  in  earlier  congressional 
consideration. 

"The  Board  is  directed  to  make  rules  affecting  shipping 
in  foreign  trade,  to  adjust  unfavorable  conditions,  and  to 
co-operate  with  other  Government  Departments  in  this 
respect.  Regulations  of  the  Shipping  Act,  1916,  govern- 
ing deferred  rebates,  "fighting  ships,"  retaliations  and  un- 
fair discrimination  are  further  strengthened  by  an  amend- 
ment regarding  violations  by  aliens  and  the  certification 
of  such  acts  to  the  Secretary  of  Commerce.  Coastwise 
shipping  laws  are  extended  to  Island  possessions  after 
February  i,  1922,  thereby  restricting  trade  between  the 
United  States  and  these  possessions  to  American  vessels, 
provided  adequate  American  service  is  established  and 
maintained.  Mails  are  to  be  carried,  so  far  as  practicable, 
on  vessels  American-built  and  documented. 

"(3)  The  instructions  governing  the  liquidation  by  the 
Board  of  Government-owned  Shipping  authorize  and  di- 
rect the  sale  of  all  vessels.  Selling  prices  are  to  be  judged 
on  the  basis  of  a  business  disposing  of  property  which  it 
is  not  forced  to  sell.  Completion  of  payment  cannot  be 
deferred  beyond  fifteen  years.  Vessels  considered  un- 
necessary to  the  American  Merchant  Marine  may  be  sold 
to  aliens  if  no  market  for  them  exists  here;  in  this  case 
payments  may  be  deferred  for  ten  years.  The  Emergency 
Fleet  Corporation  is  authorized  to  continue  in  existence 
until  all  vessels  are  sold.  Previous  legislation  limited  its 
life  to  five  years  from  the  cessation  of  the  war. 

"Proceeds  from  the  disposal  of  this  property,  except 
for  the  special  funds  authorized,  and  for  operating  capital, 
are  now  directed  to  be  turned  in  to  the  Treasury. 


528  PRINCIPLES  OF  BUSINESS 

"(4)  The  Shipping  Board  is  directed  specifically  to  in- 
vestigate the  establishment  of  new  or  additional  steam- 
ship lines  for  the  development  of  foreign  and  coastwise 
trade  and  adequate  postal  service.  It  is  authorized  to  sell 
or  charter  vessels  for  these  lines  or,  if  necessary,  to  oper- 
ate and  maintain  them  until  they  can  be  sold  or  are  found 
not  self-sustaining.  Government  service  paralleling  pri- 
vate American  service  shall  not,  however,  charge  lower 
rates. 

"The  Board  is  also  directed  to  co-operate  with  the 
Secretary  of  War  in  promoting  and  developing  ports  and 
their  facilities,  and  to  investigate  terminal  equipment." 

Webb-Pomerene  Act.— Under  the  Sherman  Act,  com- 
petitors cannot  consolidate  their  interests  if  the  effect  is 
to  fix  prices  or  restrict  output.  It  was  felt  for  a  long 
time  that  since  American  merchants  had  to  meet  foreign 
combinations,  permitted  and  even  aided  by  foreign  gov- 
ernments, in  the  struggle  for  foreign  markets,  some  allow- 
ance should  be  made  for  business  combinations  that  would 
not  affect  domestic  commerce  but  that  would  have  the 
necessary  organization  to  meet  foreign  combinations  on 
an  equal  footing. 

As  a  result  of  this  agitation,  the  Webb  Law  was  passed 
in  1 918.  It  provides  in  effect  for  any  method  of  com- 
bination so  long  as  the  result  does  not  injure  domestic 
interests.  These  companies  or  associations  all  come  un- 
der the  jurisdiction  of  the  Federal  Trade  Commission. 
Three  methods  of  organizing  such  concerns  have  come 
into  use,  and  the  large  number  of  Webb  Law  associations 
now  working  under  permit  have  assumed  one  or  the  other 


FOREIGN  TRADE  529 

of  these  forms,  with  suitable  variations,  to  meet  special 
needs.  The  first  form  is  a  tentative  association,  formed 
for  the  purpose  of  investigating  markets  and  market  con- 
ditions. It  enables  a  number  of  manufacturers,  expect- 
ing to  enter  the  foreign  field,  to  pool  their  resources  and 
conduct  a  joint  investigation.  Upon  the  result  of  their 
findings  will  depend  whether  or  not  the  members  decide 
to  form  a  more  permanent  and  effective  organization.  The 
second  form  is  a  trade  association,  as  its  members  retain 
their  individual  selling  organizations.  They  form  a  Webb 
association  to  remove  the  more  vital  features  of  compe- 
tition, make  price  agreements,  divide  the  territory,  estab- 
lish a  uniform  credit  bureau,  etc.,  but  each  sells  its  own 
goods  as  directly  to  foreign  buyers  as  if  the  association  did 
not  exist.  In  the  third  form,  the  real  Webb  corporation 
follows  the  model  so  common  in  foreign  countries,  where 
the  members  of  the  corporation  form  a  joint  stock  com- 
pany, or  a  corporation,  in  which  the  members  hold  stock 
on  some  prearranged  basis — production  capacity,  last 
year's  export  sales,  capital  stock,  or  some  other  equitable 
basis.  The  company  maintains  a  central  office,  which 
manages  all  the  export  business  of  the  member  companies. 
The  central  office  handles  the  sales  force,  the  credit  bu- 
reau, the  investigating  department,  and  clears  all  sales. 
Orders  are  allocated  according  to  prearranged  plans  set 
forth  in  the  by-laws,  on  the  basis  of  priority,  production 
capacity,  ability  to  fill  the  order  promptly,  etc.  The  mem- 
bers are  under  contract  to  allocate  a  certain  percentage 
of  their  total  output  to  foreign  trade  to  be  sold  by  the 
company  as  it  can.     The  expenses  of  the  company  office 


530  PRINCIPLES  OF  BUSINESS 

are  paid  out  of  the  working  capital,  paid  in  as  needed  by 
the  member  producers.  The  Webb  Export  Corporation 
does  not  tie  the  hands  of  a  member  producer.  If  he  feels 
inclined  to  do  so,  he  can  send  his  own  salesmen  into  the 
foreign  fields,  but  all  orders  so  received  must  be  reported 
to,  and  cleared  through,  the  company  office. 

Foreign  trade  financing. — In  financing  foreign  trade, 
two  questions  must  be  asked  :  Can  the  foreign  buyer  pay  ? 
How  will  he  pay? 

In  granting  credits  to  foreign  customers,  not  only  must 
the  risk  involved  in  the  person  or  concern  be  considered, 
but  care  must  be  shown  in  selecting  the  market  generally. 
The  internal  conditions  of  the  country,  the  position  of  its 
banks,  the  budget  balance  of  the  nation,  the  political  risk, 
the  condition  of  exchange, — all  these  questions  are  of  real 
importance.  The  concern  itself  must  be  carefully  investi- 
gated, and  since  conditions  are  as  they  are  in  most  coun- 
tries, only  late  statements  should  be  relied  upon. 

To  get  credit  information,  we  may  rely  on  the  large 
American  banks,  trade  associations,  and  such  associations 
as  the  National  Association  of  Credit  Men  and  the  Phila- 
delphia Museum.  Much  data  can  be  obtained  through  the 
Bureau  of  Foreign  and  Domestic  Trade  of  the  Depart-, 
ment  of  Commerce.  As  a  speaker  before  the  Ninth  Na- 
tional Foreign  Trade  Convention  said,  "while  the  three 
C's  of  a  credit  grantee's  qualifications  are  generally  agreed 
to  be  character,  capital,  and  capacity,  those  of  a  grantor 
in  foreign  trade  are  care,  courage,  and  confidence." 

In  making  payments,  the  foreign  house  may  rely  on  an 
open  account,  or  it  may  pay  cash  or  accept  a  sight  or 


FOREIGN  TRADE  531 

time  draft.  The  open  account  is  generally  too  hazardous 
and  the  requirement  of  cash,  in  a  competitive  market,  is 
actually  impossible.  Hence  the  draft  is  most  frequently 
used.  Very  often  drafts  are  drawn  on  foreign  banks  and 
accepted  by  them.  The  foreign  bank  does  this  because  it 
is  better  able  to  gauge  the  credit  standing  of  the  foreign 
purchaser  than  the  exporter,  or  better  able  than  an  Ameri- 
can bank  would  be,  to  whom  the  exporter  might  take  the 
purchaser's  accepted  draft.  Where  such  a  procedure  is 
used,  the  steps  would  be  as  follows :  "The  draft  would 
be  (i)  discounted  or  purchased  by  the  American  bank, 
(2)  sent  to  the  London  correspondent  of  the  American 
bank,  which  would  (3)  present  it  to  the  London  bank  on 
which  it  is  drawn,  for  acceptance.  The  draft  would  then 
(4)  be  sold  in  the  London  discount  market  and  (5)  the 
funds  credited  to  the  American  bank  which  (6)  is  in  a 
position  to  sell  drafts  against  this  balance  which  has  been 
created.  The  holder  of  the  draft  who  purchased  it  in  the 
London  discount  market  would  (7)  present  it  for  pay- 
ment on  the  due  date.  (8)  Before  this  date  the  bank 
which  has  accepted  the  draft  will  have  been  put  in  funds 
by  the  buyer  of  the  goods."  ^ 

How  American  banks  can  do  a  foreign  banking 
business. — Our  large  American  banks  have  been  anxious 
to  assist  in  foreign  trade  financing.  They  have  established 
foreign  branches,  have  affiliated  with  banks  that  have  di- 
rect connections  and  they  have  organized  Edge  Law  banks. 
Edge  banks  take  collateral  from  foreign  buyers  and  sell 
their  own  debentures  against  them,  thus  getting  the  funds 

^  Kidd's  Foreign  Trade,  pp.  154,  155. 


532  PRINCIPLES  OF  BUSINESS 

to  pay  the  exporter  for  his  shipments.  It  is  contemplated 
that  the  collateral  taken  from  foreign  buyers  may  even  be 
in  the  form  of  mortgages  on  their  properties. 

BIBLIOGRAPHY 

Hough,  B.  O.,  Ocean  Traffic  and  Trade. 

Johnson,  Emory  R.,  Principles  of  Ocean  Transportation. 

Spears,  J.  R.,  The  Story  of  the  American  Merchant  Marine. 

Gow,  William,  Marine  Insurance. 

Kidd,  Howard,  Foreign  Trade. 

Riegel,  Robert,  Merdiant  Vessels. 


CHAPTER  XXIV 

CREDIT 

CREDIT  AS  A   FACTOR  IN   BUSINESS 

What  is  credit? — Credit  is  present  purchasing  power, 
growing  out  of  the  potential  or  future  paying  power  of  the 
borrower;  and  the  extension  of  credit  on  the  part  of  the 
lender  is  contingent  upon  his  estimate  of  the  willingness 
and  ability  of  the  borrower  to  repay  according  to  the 
terms  of  the  agreement  under  which  the  credit  is  ex- 
tended/ 

Government  bonds,  bank  notes,  checks  and  promissory 
notes  are  typical  instruments  evidencing  or  implying  the 
extension  of  different  classes  of  credit  and  recording  the 
promise  of  the  debtor  to  pay.  For  convenience,  we  may 
speak  of  such  instruments  themselves  as  forms  of  credit. 

It  is  readily  seen  that  the  value  of  a  credit  instrument 
depends  upon  the  amount  of  confidence  which  the  credi- 
tor has  in  the  debtor — that  is,  in  the  debtor's  ability  and 
willingness  to  keep  his  promise. 

Credit — at  least  in  many  of  its  forms — is  scarcely  to  be 
distinguished  from  money.  Where  the  credit  is  unques- 
tionably good,  as  in  the  case  of  bank  notes  and  other 
forms  of  currency  issued  under  the  sponsorship  of  a 
stable  government,  the  credit  instruments  are  called 
money.     Personal  checks  also,  if  the  maker  is  known  to 

1  For  a  discussion  of  the  nature  and  origin  of  credit,  see  the  chap- 
ter on  "Banking." 

533 


534  PRINCIPLES  OF  BUSINESS      ' 

be  responsible,  are  for  practical  purposes  a  substitute  for 
money. 

The  uses  of  credit. — Credit,  like  money,  is  primarily 
or  fundamentally  a  medium  for  the  exchange  of  goods, 
more  convenient  and  more  elastic  than  money  itself. 
With  respect  to  its  economic  functions,  it  is  a  means  of 
placing  the  immediate  possession  or  control  of  capital 
in  the  hands  of  those  who  are  best  fitted  and  most  willing 
to  assume  the  duties  and  responsibilities  involved  in 
carrying  on  the  operations  of  industry.  The  grantor  of 
credit,  however,  reserves  the  right  to  pass  upon  the  fit- 
ness of  the  applicant  to  assume  control  of  the  tools  and 
materials  of  production  and  also  to  pass  upon  the  prob- 
ability of  the  applicant's  redemption  of  his  promise  to 
repay.  A  satisfactory  rating  as  to  "character,  capacity 
and  capital"  is  the  usual  condition  upon  which  credit  is 
granted,  but  there  is,  perhaps,  another  factor  in  the  situa- 
tion which  should  more  generally  be  taken  account  of — 
the  economic  value  of  the  credit  applicant's  proposed 
activities.  The  reason  for  this  is  that  the  safety  or  stabil- 
ity of  the  business  world  depends  upon  a  proper  adjust- 
ment of  production  to  consumption.  Such  an  adjustment 
involves  more  than  a  mere  adjustment  of  supply  to  de- 
mand— it  involves  a  conscious  and  intelligent  control  or 
direction  of  supply  and  demand. 

Economic  considerations  in  credit  extension. — In 
times  of  apparent  prosperity  the  fundamental  needs  of 
the  consumer  may  be  lost  sight  of,  and  an  undue  propor- 
tion of  productive  energy  may  be  diverted  from  the  crea- 
tion of  necessaries  to  the  creation  of  luxuries.  With  an 
unlimited  amount  ot  credit  available  for  the  securing  of 


CREDIT  535 

the  right  of  the  borrower  to  employ  the  instruments  of 
production  almost  at  will,  with  the  direct  object  of  realiz- 
ing the  largest  pecuniary  profit,  the  necessary  "balance" 
of  production  may  be  destroyed. 

Hitherto  there  has  been  practically  no  attention  paid 
to  the  economic  aspects  of  a  projected  enterprise  on  the 
part  of  the  grantor  of  the  credit  through  which  capital 
for  the  enterprise  is  to  be  secured,  although  the  ethical  or 
moral  aspects  are  often  taken  into  consideration.  Many 
capitalists,  for  example,  would  refuse  to  lend  their  money 
for  establishing  a  race  track,  on  the  ground  of  '"prin- 
ciple." If,  however,  a  clear  view  of  the  fields  of  produc- 
tion could  be  obtained,  it  would  seem  to  be  fully  as  im- 
moral for  the  capitalist  to  finance  a  non-useful  enter- 
prise, especially  if  it  were  apparent  that  there  was  an 
impending  scarcity  of  some  essential  product.  It  is  true 
that  conservative  bankers  and  other  experienced  credit 
grantors  do  scrutinize  viery  carefully  the  uses  which  are 
to  be  made  of  the  loans  which  they  make,  but  they  do  so 
chiefly  with  a  view  to  determining  whether  or  not  the 
proposed  venture  is  likely  to  be  profitable  financially. 
They  favor  enterprises  which  have  a  sound  economic 
basis  principally  because  the  prod-uction  of  essentials  is 
more  likely  to  be  permanently  profitable  than  the  produc- 
tion of  non-essentials  and  thus  to  provide  a  greater  meas- 
ure of  security  for  the  repayment  of  the  loan. 

The  alternative  for  careless  credit  granting  is  govern- 
ment supervision.  To  a  certain  extent  this  process  has 
already  taken  place  in  respect  to  investment  credit.  The 
Blue  Sky  laws  of  many  States  are  intended  to  give  to  the 
Government  the  right  to  supervise  those  who  undertake 


536  PRINCIPLES  OF  BUSINESS 

to  offer  their  credit  in  exchange  for  the  capital  of  prospec- 
tive investors.     (See  page  156.) 

During  the  European  War  governmental  credit-super- 
vision was  actually  in  effect.  The  obtaining  of  credit  for 
new  or  additional  undertakings  was  subject  to  the  ap- 
proval of  the  Capital  Issues  Committee,  created  by  the  act 
of  Congress  known  as  the  War  Finance  Corporation  Act, 
approved  April  5,  1918.  The  Committee  consisted  of 
seven  members,  three  of  whom  were  members  of  the  Fed- 
eral Reserve  Board,  sitting  in  Washington.  The  Commit- 
tee kept  in  touch  with  business  throughout  the  country 
through  sub-committees  in  each  of  the  twelve  Federal  Re- 
serve districts,  which  committees,  serving  without  com- 
pensation, investigated  and  reported  the  various  projects 
requiring  capital  in  their  respective  districts.  The  Capital 
Issues  Committee  had  power  to : 

"Investigate,  pass  upon,  and  determine  whether  it  is 
compatible  with  the  national  interest  that  there  should  be 
sold,  or  offered  for  sale  or  for  subscription  any  issue,  or 
any  part  of  any  issue,  of  securities  hereafter  issued  by  any 
person,  firm,  corporation,  or  association,  the  total  or  aggre- 
gate par  or  face  value  of  which  issue  ...  is  in  excess  of 
$100,000." 

The  Committee  during  the  first  few  months  of  its  exist- 
ence concerned  itself  only  with  issues  of  stocks  and  bonds, 
but  later  extended  its  control  to  bank  loans  of  over 
$100,000. 

If  credit  granting  is  to  be  scientific,  credit  grantors  must 
understand  the  actual  needs  of  consumers,  the  current  pro- 
duction to  satisfy  those  needs,  and  the  potential  production 
that  might  supplement  the  current  output. 


CREDIT  537 

It  is  immaterial,  of  course,  by  what  name  any  credit 
supervision  or  control  might  be  called.  The  requiring 
of  a  license  to  be  taken  out  before  a  business  might  be 
engaged  in  would  have  the  same  result  as  would  the 
limiting  of  credit.  This  is  a  problem,  then,  which  busi- 
ness must  either  solve  for  itself  or  have  solved  for  it  by 
the  Government.  It  is  understood,  of  course,  that  not  all 
classes  of  credit  are  meant  to  be  included  in  the  term  as 
used  above,  subject  to  such  regulation,  but  only  such 
credit  as  provides  capital  for  fixed  assets  and  in  some 
cases,  that  which  provides  working  capital.  Credit  ex- 
tended to  consumers,  naturally,  would  not  need  so  much 
regulation,  unless  in  the  case  of  credit  used  for  the  pur- 
chase of  "luxuries." 

The  point  of  view  of  the  credit  grantor. — The  prob- 
lems involved  in  the  control  of  credit  extension,  obviously, 
are  beyond  the  scope  of  our  present  treatment  of  the  sub- 
ject of  credit.  It  seemed  necessary,  however,  to  bring 
out  the  fact  that  these  problems  exist;  for  the  grantor 
of  credit,  if  he  takes  cognizance  of  them  in  his  dealings 
with  applicants  for  credit,  may  do  much  to  promote  the 
soundness  of  the  structure  of  -business,  since  practically 
all  of  the  world's  business  is  done  on  credit  of  one  kind 
or  another.  The  credit  grantor  need  not  attempt  to  solve 
the  whole  complicated  economic  problem,  but  will  be 
doing  his  part  if  he  refuses  to  grant  credit  excep't  to  such 
enterprises  as  he  conceives  to  have  an  economic  justifica- 
tion. He  will  assist  in  the  production  of  what  he  regards 
as  non-essentials  only  if  he  is  convinced  that  a  sufficient 
production  of  essentials  is  already  assured. 

There  is  little  if  any  danger  of  an  overproduction  of 


538  PRINCIPLES  OF  BUSINESS 

■essentials,  for  an  excess  over  market  needs  of  one  class 
of  essentials  can  be  stored  for  future  use  and  the  machin- 
ery of  production  concentrated  upon  the  class  of  essen- 
tials in  which  a  shortage  may  exist.  If  there  is  no  such 
reserve,  however,  by  reason  of  the  surplus  of  productive 
energy  having  been  devoted  to  the  production  of  non- 
essentials, it  will  be  much  more  difficult  to  make  up  a 
shortage  which  develops,  for  most  of  the  machinery  of 
production  must  continue,  as  before,  to  turn  out  that 
which  is  required  for  current  needs,  and  cannot  be 
diverted  to  the  making  up  of  the  shortage. 

The  point  of  view  of  the  credit  grantor,  then,  will  be 
one  from  which  are  considered  the  ultimate  needs  of  the 
consumer  as  well  as  the  "credit  risk."  The  highest  de- 
gree of  safety  and  the  greatest  ultimate  financial  return 
for  the  use  of  credit  can  be  secured,  obviously,  only  if 
business  in  general  is  on  the  soundest  economic  basis. 

FORMS   OF   CREDIT 

Credit  of  general  acceptability. — Credit  of  general 
acceptability,  a  substitute  for  money,  is  commonly  known 
as  money  or  currency.  A  Federal  Reserve  note,  for  ex- 
ample, recites  the  agreement  of  the  United  States  of 
America  to  pay  to  the  bearer  on  demand  the  amount  of 
money  specified  on  the  face  of  the  note,  money  in  this 
case  meaning  gold  of  a  certain  weight  and  fineness. 

Among  the  obvious  requirements  of  general  accept- 
ability are :  an  unmistakable  and  unconditional  written 
promise  of  the  obligor  to  pay  a  specified  sum  of  money 
on  demand;  a  general  belief  that  the  obligor  is  able  and 
willing  to  fulfil  the  promise;  negotiability  of  the  instru- 


CREDIT  539 

ment  upon  which  the  promise  is  recorded;^  and  positive 
means  of  identification  of  the  instrument  as  being  genu- 
ine and  not  a  counterfeit. 

In  credit  of  general  acceptabihty,  however,  we  are  not 
interested  here,  further  than  in  pointing  out  its  meaning 
and  its  place  in  the  credit  system.  In  the  ordinary  use  of 
the  term  ''credit,"  especially  in  matters  of  business,  the 
credit  referred  to  is  credit  of  limited  acceptability. 

Credit  of  limited  acceptability. — Credit  becomes 
limited  in  its  acceptability  by  reason  of  any  of  the  fol- 
lowing conditions:  deferred  date  of  payment;  lack  of  ex- 
plicitness  in  the  promise  to  pay;  lack  of  absolute  financial 
competence  or  moral  integrity  of  the  obligor;  non-negoti- 
ability of  the  instrument. 

The  important  forms  of  credit  of  limited  acceptability 
are: 

(i)   Book  accounts. 

(2)  Promissory  notes. 

(3)  Bonds. 

(4)  Stock  certificates.^ 

(5)  Checks. 

(6)  Drafts. 

(7)  Bills  of  exchange, 

(8)  Acceptances. 

(9)  Money  orders. 

(10)  Travellers'  letters  of  credit. 

(11)  Commercial  letters  of  credit. 

1  Negotiability  in  an  instrument  means  that  it  may  be  transferred 
in  such  a  way  as  to  constitute  the  transferee  the  holder   thereof, 
who  acquires  title  in  his  own  name  and  is  altogether  independent  • 
of  previous  holders. 

-  Stock  certificates  are  not  true  credit  instruments,  but  represent 
ownership  rather  than  credit. 


540  PRINCIPLES  OF  BUSINESS 

Book  accounts. — Book  accounts  are  the  open-accounts 
receivable,  due  from  customers  for  credit-sales  made  to 
them.  The  only  evidence  of  these  accounts  in  the  hands 
of  the  creditor  is  an  entry  made  by  himself  or  his  clerk 
in  his  own  books.  Naturally,  this  is  not  a  very  satisfac- 
tory evidence  of  the  amount  in  case  of  a  disagreement; 
and  accounts  in  such  a  shape  are  not  so  useful  as  an  asset 
as  they  might  be  in  another  form,  for  while  they  may  be 
bought  and  sold,  this  usually  can  be  done  only  at  a 
sacrifice.  The  practice  of  selling  book  accounts  is  seldom 
resorted  to  except  when  the  creditor  is  in  financial  diffi- 
culties. It  may  be  noted  that  in  different  parts  of  the 
country  corporations  have  been  formed  for  the  purpose 
of  purchasing  book  accounts. 

Book  accounts,  if  good,  are  often  a  satisfactory  col- 
lateral upon  which  the  merchant  may  borrow  money,  but 
even  this  practice  is  discountenanced  by  merchants. 

Promissory  notes. — A  promissory  note  is  a  written 
promise  to  pay  unconditionally  a  specified  sum  of  money 
on  demand  or  on  a  specified  date.  Promissory  notes  are 
ordinarily  given  upon  the  occasion  of  the  borrowing  of 
money  or  the  purchase  of  real  estate  or  other  property, 
when  only  a  portion,  or  none,  of  the  "consideration"  is 
"cash."  Notes  are  also  taken  by  creditors  in  settlement 
of  long-standing  accounts  "in  order  to  get  the  matter 
into  better  shape,"  which  means  that,  as  an  asset,  a  new 
note  is  better  than  an  old  open-book  account.  It  is  an 
obligation  which  the  customer  is  likely  to  pay  when  it 
falls  due,  and  one  upon  which  suit  may  be  brought,  if 
necessary,  without  additional  evidence  of  the  debt,  since 
it  bears  the  debtor's  signature.     It  may  also  be  used  as 


CREDIT  541 

security  for  a  loan  from  the  bank,  or  it  may  be  sold 
outright. 

When  the  merchant  takes  a  note  in  settlement  of  a 
book  account,  he  will  see  that  the  note  bears  interest,  and 
may  add  to  the  amount  of  the  note  a  sum  sufficient  to 
equal  interest  accumulated  for  the  time  the  account  has 
been  due. 

Promissory  notes  are  classed  as  "secured"  or  "unse- 
cured," with  respect  to  whether  or  not  there  is  a  condi- 
tional transfer  of  property  rights  as  a  security  for  the 
satisfaction  of  the  note;  as  ''single-name"  or  "double- 
name"  paper,  with  respect  to  the  number  of  signers  or 
indorsers  of  the  note;  and  as  "short-term"  or  "long- 
term"  with  respect  to  the  date  of  maturity.  "Commer- 
cial" or  short-term  notes  are  usually  payable  in  not  more 
than  90  days,  although  it  is  probable  that  any  note  of  six 
months  or  less  would  be  classed  as  short-term  rather  than 
long-term.  Promissory  notes  may  also  be  drawn  payable 
"on  demand;"  or  "on  or  before"  the  date  of  maturity. 
A  demand  note  may  be  paid  at  any  time  by  the  debtor,  and 
the  creditor  may  at  any  time  insist  upon  immediate  pay- 
ment. If  the  note  is  payable  "on  or  before,"  the  creditor 
may  not  compel  payment  until  the  date  of  maturity,  but 
the  debtor  may,  at  his  own  option,  make  payment  at  any 
intervening  time,  the  creditor  being  legally  bound  to 
accept. 

Bonds. — A  bond  is  a  written  promise,  under  seal,  to 
pay  a  specified  sum  of  money  (usually  $1,000),  at  a  fixed 
time  in  the  future,  usually  more  than  ten  years  after  the 
promise  is  made,  and  is  usually  one  of  a  series  of  similar 
bonds,  all  carrying  interest  at  a  fixed  rate. 


542  PRINCIPLES  OF  BUSINESS 

Bonds  are  used,  as  a  rule,  as  a  means  of  obtaining 
capital  for  permanent  needs,  as  for  the  purchase  of  fixed 
assets  or  the  securing  of  permanent  working-capital, 
while  promissory  notes  are  a  means  of  financing  opera- 
tions that  require  additional  capital  for  only  a  limited 
time. 

Bonds  may  be  "registered"  or  "bearer"  bonds,  in  the 
latter  case  being  transferable  by  delivery  and  in  the 
former  case  by  endorsement  and  delivery.  They  are 
usually  excellent  collateral  upon  which  the  holders  may 
borrow  money.  Bonds  may  be  "mortgage"  bonds,  i.e., 
secured  by  the  mortgage  of  definite  property,  real  and 
personal;  "collateral"  bonds,  i.e.,  secured  by  the  pledge 
of  stock  or  bonds;  or  "debenture,"  i.e.,  wholly  unsecured. 

Since  the  bond  is  a  long-term  credit  instrument,  it  is 
more  commonly  issued  by  corporations  than  by  other 
business  organizations  or  by  individuals.  The  corpora- 
tion has  a  longer  expectation  of  life  than  has  the  individ- 
ual or  partnership  form  of  business  enterprise,  and  is  also 
more  subject  to  regulation  by  the  Government,  hence  the 
bond  of  a  corporation  is  more  favorably  regarded  by  the 
investor  than  is  the  bond  of  an  individual  or  partnership. 

Stock  certificates. — While  bonds  represent  money  lent 
to  the  corporation,  or  other  issuer  of  the  bonds,  and  a 
definite  obligation  upon  the  part  of  the  issuer  to  repay  at 
the  specified  time,  stock  certificates  represent  ownership 
in  the  corporation  or  association,  and  not  an  obligation 
of  the  corporation  to  make  any  predetermined  payment. 
Stock  certificates,  therefore,  are  not  true  credit-instru- 
ments. There  is  a  promise,  however,  expressed  or  implied, 
of  the  corporation  as  an  entity  to  return  to  the  stock- 


CREDIT  543 

holder  as  an  owner  his  predetermined  or  proportionate 
share  of  the  profits,  if  any  are  made,  and  his  proportion- 
ate share  of  the  assets,  in  case  the  corporation  is  dissolved, 
this  obligation  being  in  consideration  of  money  or  capital 
advanced  to  the  corporation  to  be  used  in  the  carrying  on 
of  its  business  for  the  purpose  of  making  profits  for  its 
stockholders.  Thus  the  corporation,  although  not  liable  to 
its  stockholders  for  any  specific  payments,  is  liable  to  the 
stockholders  for  an  accounting  and  a  compliance  with 
the  agreement  under  which  the  shares  were  purchased. 

Checks. — Of  the  various  forms  of  credit  instruments 
that  have  been  evolved,  the  bank  check  is  one  of  the  most 
useful.  It  is  an  order  addressed  to  a  bank  in  which  the 
maker  of  the  check  has  funds  on  deposit,  requesting  the 
bank  to  pay  upon  presentation  of  the  clieck,  upon  or  after 
the  date  of  the  check,  a  specified  sum  of  money  to  the 
person  named  as  payee  on  the  face  of  the  check,  or  to 
his  order.  The  check  may  be  drawn  payable  to  "cash" 
or  to  "bearer,"  in  which  case  the  holder  may  cash  it 
regardless  of  his  identity. 

If  payment  should  be  refused  by  the  bank  on  which  a 
check  is  drawn,  the  check  becomes  in  reality  a  promissory 
note  payable  by  the  maker  on  demand  of  the  payee. 

If  the  check  is  payable  at  the  time  it  is  made,  as  almost 
all  checks  are,  and  if  payment  is  refused  by  the  bank 
because  of  lack  of  sufficient  funds  to  the  credit  of  the 
maker  of  the  check,  the  payee  may  have  recourse  not  only 
to  such  legal  proceedings  as  are  open  to  holders  of  prom- 
issory notes  in  default,  but  in  some  States  and  under  cer- 
tain conditions  may  institute  criminal  as  well  as  civil 
proceedings  against  the  maker. 


544  PRINCIPLES  OF  BUSINESS 

Certified  checks. — A  certified  check  is  a  bank  check 
which  bears  the  stamp  of  the  bank  upon  which  it  is  drawn, 
attesting  the  fact,  in  effect,  that  the  depositor  has  funds 
out  of  which  the  check  will  be  paid  upon  presentation,  the 
bank  assuming  the  responsibility  for  payment  and,  in 
order  to  protect  itself,  setting  aside  immediately  a  sufifi- 
cient  sum  out  of  the  depositor's  funds  to  cover  the  check 
when  it  is  presented. 

Cashier's  checks. — A  cashier's  check  is  an  order  on  a 
bank  signed  by  the  cashier  of  the  bank  itself.  Such 
checks  are  used  by  a  bank  in  paying  its  own  obligations, 
or  may  be  issued,  at  a  depositor's  request,  payable  to  a 
person  designated  by  the  depositor,  against  whose  account 
the  amount  of  the  check  is  immediately  charged.  The 
cashier's  check  possesses  the  same  acceptability  as  the 
certified  check,  since  each  is  an  obligation  of  the  bank  it- 
self. 

Bank  drafts. — The  bank  draft,  a  form  of  check,  differs 
from  the  cashier's  check  in  that  instead  of  being  an  order 
drawn  by  the  bank  upon  itself,  it  is  drawn  upon  another 
bank  in  which  the  issuing  bank  has  funds  on  deposit. 

Bills  of  exchange. — A  bill  of  exchange  is  an  order 
drawn  by  one  person  or  firm  upon  another,  requesting  the 
person  or  firm  upon  whom  it  is  drawn  to  pay,  upon  pres- 
entation or  at  a  specified  time  thereafter,  a  specified  sum 
of  money  to  the  person  or  firm  named  as  payee  on  the 
face  of  the  instrument.  The  payee  may  be,  and  usually 
is,  the  same  person  as  the  drawer  of  the  bill. 

A  domestic  bill  of  exchange — that  is,  a  bill  payable  in 
the  country  of  its  origin,  is  called  a  commercial  draft. 

Commercial   drafts   most  often  arise   in   transactions 


CREDIT  545 

such  as  a  sale  of  goods  by  one  merchant  to  another,  often 
to  a  consignee  in  a  distant  city,  the  draft  being  made  pay- 
able to  the  drawer  himself  or  to  an  agent  whom  he  de- 
putes to  make  the  collection.  Shipments  are  frequently 
made  "sight  draft  attached  to  bill  of  lading,"  which  means 
that  the  person  to  whom  the  goods  are  shipped  must  pay 
the  draft  before  the  bill  of  lading,  which  carries  title  to 
the  goods,  will  be  released,  i.e.,  given  to  the  consignee  by 
the  person  who  holds  it  pending  payment  of  the  draft. 
Upon  payment  of  the  draft  the  consignee  gets  the  bill  of 
lading,  presents  it  at  the  freight  warehouse,  and  receives 
his  goods. 

In  foreign  trade  the  shipper  makes  use  of  the  bill  of 
exchange  in  the  same  general  manner,  but  on  account  of 
the  length  of  time  goods  must  be  in  transit  before  the 
consignee  receives  and  pays  for  them,  the  practice  is  to 
sell  or  discount  the  draft  with  bill  of  lading  attached  at 
the  shipper's  own  bank,  which  bank  then  forwards  the 
instruments  for  collection  by  a  correspondent  in  the  for- 
eign city. 

Acceptances. — Acceptances  are  drafts  which  have 
been  presented  to  the  drawee  and  which  he  has  agreed  to 
pay.  A  description  of  the  different  forms  of  trade  and 
bankers'  acceptances  will  be  found  in  the  chapter  on 
"Banking."  Acceptances  are  rapidly  replacing  open  book 
accounts  in  credit  transactions  between  merchants.  The 
passage  of  the  Federal  Reserve  Act  made  the  use  of  ac- 
ceptances especially  desirable,  for  under  the  act  a  prac- 
tically unlimited  amount  of  currency  may  be  issued 
against  short-term  commercial  paper.  Acceptances,  ac- 
cordingly,  can   readily  be  converted  into  money.     The 


546  PRINCIPLES  OF  BUSINESS 

increase  in  the  use  of  acceptances  is  not  surprising,  for 
in  addition  to  its  being  convertible  into  money,  the 
acceptance  has  many  advantages  over  the  open  book 
account.  It  is  a  much  better  evidence  of  the  debt;  it 
definitely  makes  possible  the  prompt  collection  of  the 
debt,  and  it  may  readily  be  negotiated  by  the  holder. 

Money  orders. — Postal  and  express  money  orders  are 
orders  to  pay,  drawn  by  the  post-office  or  express  com- 
pany upon  itself,  through  an  authorized  employee,  and 
are  payable  to  the  order  of  the  designated  payee  upon 
presentation  at  the  designated  office  of  payment. 

Traveller's  letters  of  credit. — The  circular  letter  of 
credit  used  by  travellers  in  foreign  parts  is,  practically, 
a  bank  draft  drawn  upon  a  number  of  foreign  banks 
collectively,  requesting  them,  or  any  of  them,  to  pay  to 
the  holder,  in  such  installments  as  the  holder  may  require, 
an  aggregate  amount  not  to  exceed  that  specified  in  the 
letter  of  credit.  Each  payment  when  made,  of  course, 
is  shown  upon  the  letter,  so  that  subsequent  payors  may 
know  how  much  remains  to  the  traveller's  credit.  The 
correspondent  banks  are  reimbursed  by  the  issuing  bank 
for  whatever  amounts  they  may  have  paid  to  the  holder 
of  the  letter. 

Commercial  letters  of  credit. — The  commercial  letter 
of  credit  is  used  to  enable  an  importer  to  make  payment 
for  goods  shipped  by  a  foreign  merchant.  Having 
arranged  for  the  necessary  credit  at  his  local  bank,  the  im- 
porter forwards  to  the  foreign  merchant  the  commercial 
letter  of  credit,  which  letter  authorizes  the  shipper  to 
draw  on  the  issuing  bank  up  to  the  amount  specified  in  the 
letter  of  credit.     Shipment  of  the  goods  may  be  made 


CREDIT  547 

under  a  bill  of  lading  made  out  to  the  order  of  the  issu- 
ing bank.  The  shipper  then  discounts  the  draft  at  his 
local  bank  with  bill  of  lading  and  other  shipping  docu- 
ments attached.  From  here  they  are  forwarded  to  the 
importer's  bank — the  bank  which  issued  the  letter  of 
credit.  This  bank,  upon  receipt  of  the  documents,  reim- 
burses the  foreign  bank  at  which  the  shipper  discounted 
his  documentary  draft  as  authorized  by  the  letter  of 
credit. 

The  procedure  in  the  use  of  bankers'  domestic  accept- 
ances is  much  the  same  as  that  described  above.  The 
purchaser  living  at  a  distance  from  the  seller — both,  how- 
ever, being  within  the  United  States — arranges  with  his 
bank  to  "accept"  a  draft  to  be  drawn  upon  it  by  the 
shipper  of  the  goods.  This  "bankers'  acceptance"  is 
equivalent  to  a  cash  payment,  from  the  point  of  view  of 
the  shipper,  for  it  is  an  obligation  of  a  bank  and  there- 
fore readily  negotiable.  For  a  description  of  acceptances 
see  the  chapter  on  "Banking." 

Specimen  letters  of  credit — traveller's,  foreign  com- 
mercial and  domestic  commercial — are  shown  herewith. 


548  PRINCIPLES  OF  BUSINESS 


LADENBURG,   THALMANN   &   CO. 

No.  00000  Amount,  £1,000. 

New   York,   December   1st,   1917. 

To  Messrs.  the  Banks  and  Bankers. 

Mentioned  on  the  accompanying  list  of  correspondents.     . 

Gentlemen  : 

We  beg  to  introduce  to  you  the  bearer  of  this  letter,  Mr.  John 
Doe  of  New  York,  in  whose  favor  we  have  opened  a  credit  for 
say,  One  Thousand  Pounds  Sterling,  with  The  Union  Bank  of 
Australia,  Ltd.,  London,  to  be  in  force  until  July  1st,  1918. 

We  request  you  to  negotiate demand  drafts  on  the  above 

mentioned  firm  bearing  the  clause  drawn  against  L.  of  C.  No.  00000 
of  L.  T.  &  Co.  N.  Y."  on  the  most  favorable  terms-,  deducting  all 
your  charges  and  endorsing  all  payments  on  the  second  page  in 
the   same   currency  in  which  this  credit  is  issued. 

Recommending  Mr.  Doe  to  your  best  attention. 
We  remain.   Gentlemen, 
Yours  truly, 

L.  T.  &  Co. 

SIGNATURE  OF  BEARER  OF  THIS  LETTER  OF 
CREDIT  WILL  BE  FOUND  ON  ACCOMPANYING 
LETTER  OF  INDICATION. 

Please  return  this  letter  to  us  after  the  last  payment  has  been  made. 
Circular  Letter  of  Credit 


CREDIT  549 


Credit  No.  1234 

$5,000 

GUARANTY  TRUST  COMPANY  OF  NEW  YORK 

New  York,  January  15th,  1918. 

To  Messrs.  Fulton  &  Co., 

New   York. 

Dear  Sirs  : 

We  hereby  authorize  your  drafts  on  us,  drawn  at  three  (3)  days 
sight  for  account  of  Messrs.  A.  Brou'n  &  Co.,  for  any  sum  or  sums 
not  exceeding  in  all  Five  Thousand  Dollars. 

The  drafts  must  be  drawn  prior  to  July  15th,  1918,  and  advised 
to  us  at  the  time  of  drawing. 

And  we  hereby  engage  that  drafts  drawn  in  compliance  with  the 
terms  of  this  Credit  shall  be  duly  honored  on  presentation. 

GUARANTY  TRUST  COMPANY  OF  NEW  YORK, 

John  Doe,  Pres., 
Richard  Roe,  Secy. 

N.    B. — Please    mark    drafts:      "Drawn    under 

credit  No.  1234,  dated  New  York,  January 
ISth,  1918,"  and  the  amount  of  each  draft 
is  to  be  endorsed  hereon. 

Domestic  Letter  of  Credit  (Commercial) 


550  PRINCIPLES  OF  BUSINESS 


Credit  No.   1234 

$50,000 

GUARANTY  TRUST  COMPANY  OF  NEW  YORK 

FOREIGN    DEPARTMENT 


New  York,  December  1st,   1917. 

Messrs.  Gonzales  Hermanos, 
Pernambuco. 

Gentlemen : 

We  hereby  authorize  you  to  value  on  GUARANTY  TRUST 
COMPANY  OF  NEW  YORK,  NEW  YORK,  for  account  of 
Messrs.  John  Simpson  Sons  &  Co.,  up  to  an  aggregate  amount  of 
Fifty  Thousand  Dollars,  U.  S.  ccy.,  available  by  your  drafts  at 
ninety  days  sight  against  shipment  of  ^offee  to  New  York.  In- 
surance covered  by  buyers. 

Bills  of  Lading  for  such  shipments  must  be  made  out  to  the 
order  of  the  Guaranty  Trust  Company  of  New  York,  unless  other- 
wise specified  in  this  credit. 

Consular  Invoice  and  One  Bill  of  Lading  Must  Be  Sent  By 
THE  Banker  Negotiating  Drafts  Direct  to  Guaranty  Trust 
Company  of  New  York,  New  York. 

Te  remaining  documents  must  accompany  the  drafts  drawn  on 
Guaranty   Trust    Company  of   New   York,   New   York. 

The  amount  of  each  draft,  negotiated,  together  with  date  of 
negotiation,  must  be  endorsed  on  back  hereof. 

We  hereby  agree  with  bona  fide  holders  that  all  drafts  drawn  by 
virtue  of  this  Credit  and  in  accordance  with  the  above  stipulated 
terms  shall  meet  with  due  honor  upon  presentation  at  the  Office 
of  Guaranty  Trust  Company  of  New  York,  New  York,  if  drawn 
and   negotiated   prior   to   July  31st,   1918. 

GUARANTY  TRUST  COMPANY  OF  NEW  YORK, 

John  Doe. 

N.  B.  Drafts  drawn  under  this  Credit 
must  state  that  they  are  "drawn 
UNDER  Letter  of  Credit  No.  1234. 
$50,000.  Dated  December  1st,  1917." 

Foreign  Letter  of  Credit  (Commercial) 


CREDIT 


551 


TRUST  RECEIPT. 


Received  from  the  guaranty  Trust  Co.  of  Ne>  York  the  following  goods 
and  merchandise,  their  property,  specified  in  the  Bill  of  Lading  per  S.  S.  San.'C^TtC  *>  AaA- 
Dated-ff^^-c2-'»^'-t-^  ///^^7-  "^^'^=^- marked  and  numbered  as  follows: 


Sio  ■=    Sir  (^cJ2jt.^  or-j^^iArt--5Ltt-o 


and,  in  consideration  thereof, 


HEREBY  AGREE  TO  HOLD  SAID  GOODS  IN  TRUST  fOf 


them,  and  as  their  property,  with  liberty  to  sell  the  same  for  their  account,  and  further 
agree,  in  case  rf  sale  to  band  the  proceeds  to  them  to  apply  "against  the  acceptances  of 

The  Guaranty  Trust  Co.  of  New  York  on  | 1  account,  under  the  terms  of  the 

Letter  of  Credit  No.' ■2L2>^S'  issued  for  j r  account  and  for  the  payment  of  an? 


The  Guaranty  Trust  Co.  of  New  York  may  at  any  time  cancel  this  trust  and  take 
possession  of  said  goods,  or  of  the  proceeds  of  such  of  the  same  as  may  then  have  been  sold, 
wherever  the  said  goods  or  proceeds  may  then  be  found  and  in  the  event  of  any  suspension, 

or  failure,  or  assignment  for  the  benefit  of  creditors,  on  ] [  part,  or  of  the  non-fulfill- 
ment of  any  obligation,  or  of  the  non-payment  at  maturity  of  any  acceptance  made  by 
J [  under  said  credit,  of  under  any  other  credit  issued  by  THE  Guaranty  Trust  Co. 

OF  New  York  on  j  — — -  \  account  or  of  any  indebtedness  on  | [  part  to  them,  all 

phUgatio.ns,  acceptances,  indebtedness  and  liabilities  whatsoever  shall,  thereupon  (with  or 

without  notice)  mature  and  become  due  and  payable.     The  said  goods  while  in  ] { 

, . .  I  our  f 

JiaDi&^haU  be  fully  insured  against  loss  by  fire. 

■Dated,  New  York  City 


(Signed) 


<W^ 


ZZt£>^^<j^r::: 


£f5da :  -/  ^.f. stg. 


(Given  to  Bank  by  Importer  upon  receiving  shipping 
documents.  A  bailee  receipt  is  also  taken  by  the 
bank  if  the  importer  employs  an  agent  to  dispose 
of  the  goods) 


552  PRINCIPLES  OF  BUSINESS 

BAILEE    RECEIPT. 

Spwibpli  from  the  Guaraiity  Trust  Company  of  New  York^ 

oose  of  selling  sajtie  for  account  of  said  Company : 
7aLA<^.af:£^^^a^ikx^. .^ 

marked  and  num,bered.-^^^  ^   4xi   ^Q-^^i^^n.^^ 


and..~„,'Ut€< hereby  undertake  to  sell  the  property  herein  specified,  for 

account  of  the  said  Company,  and  collect  the  proceeds  of  the  sale  or  sales  thereof, 
and  deliver  the  same  immediately,  on  receipt  thereof  to  the  Said  Company,  to  be 

applied  to  the  credit  of-^iooao^ .-r^^,T£^..^..-.-_...-  .^r  .^^--,: .." — . 

hereby  acknowledging  ffAAiXA.e£^rea- .-to  be  Bailee  of  the  said  property  for  the  said 

Company,  and A»n^ do  hereby  assign  and  transfer  to  the  said  Cornpany 

the  accounts  of  the  purchaser  or  purchasers  of  said  property  to  the  extent  of  the 
purchase  price  thereof,  of  which  fact  notice  shall  be  given  at  the  time  of  delivery  of 

the  said  property  bij-A/i^ to  suchpurchaser  or  purchasers  and  allihvoices  therefor 

shall  have  imprinted,  written  or  stamped  thereon  by^fi-a^^ the  following  :. 

"Transferred  and  payable  to  GUARAJ^TY  TRUST  COMPANY  OF  JfEW 
YORK,  140  Broadway,  JVew  York.'' 

If  the  said  property  is  not  sold  and  the  proceeds  so  deposited  within  ten  days 
from  this  date,Ai3%^  jundertake  to  return  all  documents  at  onceon  demand,  or  to 
puj  the  value  of  the  goods,  at  the  Company's  option. 

The  said  goods  while  in  \  - —  [  hands  shall  be  fully  insured  against  loss  by  fire 

The  terms  of  this  receipt  a,nd  agreement  shall  continue  and  apply  to  therrier- 
chandise  above  referred  to  whether  or  not  control  of,  the  same,  or  any  part  thereof, 
be  at  any  time  restored  to  the  Guaranty  Trust ,  Company  of  JVew  York,  and 
subsequently  delivered  to  us^ 

Dated  at  JVew  York,.' 


<S^^<-'*-^''^ 


"V^^TO—y 


(Given  to  Bank  by  Bailee,  who  is  usually  the  agent  or  broker 
of  the  importer,  in  cases  where  importer  employs  an  agent 
to  handle  the  consignment  on  commission  or  otherwise.) 


CREDIT  553 

CLASSES   OF    CREDIT 

Kinds  o£  credit  used  in  business  transactions. — The 

various  kinds  of  credit  used  in  business  transactions  may 
be  classified  as  being: 

1.  Investment  credit. 

2.  Mercantile  credit. 

3.  Banking   credit. 

4.  Personal  credit. 

Investment  credit. — Investment  credit  is  that  which 
is  concerned  with  long-term  loans  or  other  investments, 
represented  by  such  instruments  as  bonds,  notes,  real- 
estate  mortgages,  or  stock  certificates. 

Investment  funds  are  obtainable  from  individual  in- 
vestors, investment  bankers,  and  from  individuals  or  in- 
stitutions acting  as  custodians  or  trustees  of  the  funds 
of  others,  and  in  some  cases  from  institutions,  such  as 
insurance  companies,  having  surplus  funds  of  their  own 
to  invest.  Commercial  banks,  however,  while  they  re- 
main within  their  proper  sphere  of  activity,  do  not  lend 
money  for  investment  but  only  make  short-term  loans, 
presumably  for  the  furthering  of  legitimate  mercantile  or 
other  transactions  which  are  to  be  carried  to  completion 
within  the  period  of  the  loan  and  which  are  often,  al- 
though not  necessarily,  depended  upon  to  furnish  the 
funds  out  of  which  the  loan  will  be  repaid.  For  discus- 
sions of  problems  involving  investment  credit,  see  the 
chapters  on  "Financing"  and  "Banking." 

Mercantile  credit. — Mercantile  credit  is  the  credit  ex- 
tended by  merchant  to  merchant,  for  the  purpose  of  facili- 
tating the  movement  of  goods  from  the  producer  to  the 
retailer — and   ultimately,    of   course,    to    the   consumer. 


554  PRINCIPLES  OF  BUSINESS 

Credit,  to  the  extent  of  the  accumulated  costs  of  the 
goods,  must  very  frequently  be  extended  by  the  manu- 
facturer to  the  merchant,  by  the  merchant  to  the  jobber, 
and  by  the  jobber  to  the  retailer,  the  time  in  each  case 
being  sufficient  to  enable  the  purchaser  to  resell  the  goods 
and  collect  the  money  from  his  customers. 

Successful  merchants,  whose  business  reputation  and 
financial  standing  are  good,  have  no  difficulty  in  obtain- 
ing short-term  loans  from  banks.  They  are  enabled  to 
take  advantage  of  tlie  numerous  discounts  for  cash  pay- 
ments and  of  the  many  opportunities  for  making  a  "quick 
turn"  on  deals  which  require  a  little  extra  capital  to 
handle.  The  merchant  who  cannot  avail  himself  of  such 
discounts  and  other  opportunities  for  saving  or  making 
is  at  a  hopeless  disadvantage.  The  merchant  who  can 
finance  his  business  altogether,  however,  without  the  use 
of  mercantile  credit,  is  rarely  found. 

The  terms  of  mercantile  credit  constantly  tend  toward 
being  of  shorter  duration,  this  being  due  to  the  greater 
speed  with  which  business  is  now  carried  on,  as  compared 
with  the  time  required  to  complete  business  transactions 
in  the  days  when  mercantile  credit  had  its  origin.  Rapid 
railroad,  motor-truck  and  steamship  transportation  and 
telegraph  and  telephone  service  are  among  the  factors 
which  have  brought  about  a  quicker  turnover  of  goods. 
Terms  of  longer  than  sixty  or  ninety  days  are  now  ex- 
ceptional, save  in  the  businesses  that  handle  expensive 
or  slow-moving  goods. 

Since  the  establishment  of  the  Federal  Reserve  System 
acceptances  are  supplanting  open  book  accounts  in  mer- 
cantile-credit transactions.     In  cases  where  the  credit  is 


CREDIT  555 

in  the  form  of  an  open  book  account,  a  discount  will  us- 
ually be  offered  for  cash  or  prompt  payment.  Payment 
within  lo  days  is  usually  regarded  as  a  cash  payment. 
When  goods  are  sold  on  terms  of  30  days,  for  example, 
and  the  invoice  is  marked  "2/10  net  30"  the  conditions 
are  that,  if  the  bill  is  paid  within  10  days  after  the  date 
of  the  invoice,  2  per  cent  discount  may  be  deducted,  the 
full  amount  of  the  bill  being  due  30  days  after  the  date 
of  the  invoice,  in  case  the  discount  offer  is  not  accepted. 
In  other  words,  the  purchaser  is  penalized  2  per  cent  for 
deferring  payment,  and  he  is  obliged  to  pay  in  any 
case  in  only  20  days  more.  The  money  which  thus  he 
borrows  from  the  vendor  costs  him  2  per  cent  for  20 
days,  or  i/io  of  i  per  cent  a  day,  or  36.5  per  cent  a  year. 
It  would  seem  that  in  such  a  case,  which  is  typical,  both 
vendor  and  purchaser  must  be  badly  in  need  of  more 
w^orking  capital,  else  the  one  could  not  afford  to  offer 
such  an  inducement  for  early  payment  nor  the  other  to 
neglect  to  accept  the  offer.  In  actual  business  practice, 
the  rates  of  trade  discount  figured  as  above  may  vary 
from  6  per  cent  to  72  per  cent  a  year.  The  obvious  in- 
ference is,  that  merchants  would  do  well  to  adopt  the 
trade-acceptance  system,  by  which  the  signing  of  an  ac- 
ceptance, or  draft,  becomes  practically  the  equivalent 
of  a  cash  payment,  since  the  vendor  can  endorse  the  ac- 
ceptance and  discount  it  at  the  bank  and  allow  the  pur- 
chaser the  benefit  of  "cash"  prices. 

Banking  credit. — Banking  credit  is  the  credit  which 
banks  extend  to  business  enterprises  for  the  purpose  of 
equalizing,  or  distributing,  the  financial  burden  of  con- 
ducting a  commercial  business.     The  commercial  bank  in 


556  PRINCIPLES  OF  BUSINESS 

no  way  disparages  long-term  investments,  for  long-term 
loans  are  fully  as  essential  to  business  as  are  short-term 
loans,  but  the  machinery  of  the  commercial  bank  is  not 
designed  for  handling  any  but  short-term  loans,  based 
upon  liquid  or  readily  convertible  assets. 

The  merchant  who  sells  goods  on  credit  and  who  must 
wait  perhaps  90  days  for  payment,  or  the  dealer  who  must 
pay  cash  for  a  stock  of  goods,  borrowing  the  money  from 
the  bank  and  repaying  the  bank  when  he  has  had  time 
(within  90  days,  as  a  rule)  to  resell  the  goods,  are  ex- 
amples of  the  users  of  banking  credit. 

Banking  credit  is  thus  seen  to  be  closely  connected  with 
mercantile  credit,  since  the  merchant  must  often  obtain 
banking  credit  for  himself  in  order  to  be  in  a  position  to 
extend  mercantile  credit  to  his  customers.  He  must  have 
an  adequate  working  capital,  in  order  that  he  may  be  in 
a  position  at  once  to  replenish  his  stock  when  it  is  de- 
pleted by  sales  to  his  customers. 

In  general,  there  are  three  methods  by  which  the  mer- 
chant may  avail  himself  of  the  bank's  readiness  to  make 
short-term  loans  on  good  security.  He  may  secure  notes 
from  his  customers  and  borrow  money  on  them  as  col- 
lateral ;  he  may  borrow  money  on  his  own  note  without 
specific  collateral,  in  which  case  he  must  present  to  the 
bank  a  satisfactory  "financial  statement;"  or  he  may  sell 
his  own  note  on  the  open  market,  through  a  note-broker, 
by  which  means  funds  may  be  secured  indirectly  from 
other  banks,  if  his  own  bank  happens  to  be  short  of  loan- 
able funds. 

The  Federal  Reserve  Act  has  made  very  much  easier 
the  obtaining  of  ample  banking  credit  by  merchants  of 


CREDIT  557 

satisfactory  mora!  and  financial  rating.  It  would  appear 
that  shortage  of  "loanable  funds"  is  a  thing  of  the  past 
in  the  country's  banking  system,  for  the  supply  of  cur- 
rency now  increases  or  diminishes  in  accordance  with  the 
needs  of  business.  The  obvious  effect  of  the  Federal 
Reserve  System  with  respect  to  the  above-mentioned 
methods  used  by  the  merchant  in  "raising"  money  is  to 
develop  as  a  standard  practice  the  securing  of  a  note  or 
"acceptance"  from  the  customer  who  buys  goods  on 
credit,  and  the  discounting  of  this  acceptance  by  the  mer- 
chant at  his  own  bank.  The  use  of  the  acceptance,  of 
course,  increases  the  merchant's  contingent  liability,  since 
the  acceptance  bears  his  indorsement,  and  to  some  extent, 
accordingly,  the  merchant's  personal  borrowing  power  is 
diminished.  This  disadvantage  is  offset  by  the  fact  that 
funds  secured  by  the  discounting  of  customers'  notes  and 
acceptances  should  meet  practically  all  the  need  the  mer- 
chant has  for  banking  credit.  The  borrowing  of  money 
on  his  own  note,  therefore,  will  less  frequently  be  neces- 
sary, as  will  the  sale  of  his  own  notes  through  a  note- 
broker. 

A  more  detailed  consideration  of  banking  credit  as 
well  as  of  the  discounting  of  commercial  paper,  will  be 
found  in  the  chapter  on  "Banking." 

PERSONAL  CREDIT 

Credit  granted  by  the  retailer  to  the  consumer. — As 

distinguished  from  investment  credit,  mercantile  credit, 
and  banking  credit — the  credit  granted  to  the  consumer 
is  called  "personal  credit."  It  may  be  noted  here  that 
while  credit  in  general  is  an  aid  to  business,  enabling  busi- 


558  PRINCIPLES  OF  BUSINESS 

ness  to  be  conducted  on  a  larger  scale  and  with  greater 
facility,  and  also  at  less  economic  cost,  than  would  b.e  the 
case  if  the  transfer  of  actual  money  were  required  in  each 
transaction,  these  benefits  of  the  credit  system  are  con- 
tingent upon  promptness  of  payment  when  an  account  is 
due,  whether  it  is  due  in  ten  days  or  in  ten  years,  and 
also  upon  payment  without  undue  expense  of  bookkeep- 
ing and  final  collection.  It  is  unfortunately  true,  that  the 
retail  credit  system — that  is,  of  the  part  of  the  credit  sys- 
tem which  involves  what  is  known  as  personal  credit — 
is  far  from  standardized.  Here,  as  in  other  departments 
of  a  business,  lack  of  standardization  means  a  continuous 
waste  of  time  and  energy. 

The  desire  to  do  a  large  volume  of  business,  to  out-do 
competitors,  leads  the  retailer  to  make  it  as  easy  as  pos- 
sible in  every  way  for  people  to  purchase  his  goods.  It 
is  much  easier  for  the  customer  to  select  a  few  articles  and 
have  them  charged  and  delivered  than  to  pay  for  them 
and  wait  for  the  "change,"  even  if  the  package  is  not 
taken  away  at  the  time.  Again,  to  be  able  to  say : 
"Charge  this,  please,"  somehow  sets  one  apart  from  the 
persons  who  are  required  to  pay  cash,  for  fear  that  other- 
wise they  would  not  pay  at  all.  It  is  also  convenient  to 
be  able  to  order  goods  by  telephone.  Not  the  least  of  the 
conveniences  connected  with  the  personal-credit  system 
is  the  service  of  the  merchant  in  keeping  the  customer's 
accounts,  and  sending  them  at  the  end  of  the  month, 
nicely  arranged  and  all  added  up.  Many  people  want  to 
know  the  weekly  or  monthly  amount  of  the  milk  bill,  the 
butcher's  bill,  the  grocer's  bill,  and  the  rest  of  the  bills, 
but  few  would  take  the  care  to  keep  account  of  the  items 


CREDIT  559 

if  the  items  of  each  different  purchase  were  paid  for 
separately. 

The  need  for  getting  goods  on  credit,  accordingly,  is 
one  which  is  based  on  fundamental  elements  of  human 
nature,  and  is  a  need  which  must  be  satisfied.  There 
would  be  no  economic  advantage,  even  to  the  merchant, 
in  doing  away  with  retail  credit.  The  records  of  sales 
should  be  kept  in  detail  in  any  case,  in  order  that  the 
merchant  may  know  the  amount  of  his  sales  of  each  class 
of  goods  and  who  has  bought  them.  The  charge  account 
saves  the  merchant's  time  as  well  as  the  time  of  the  cus- 
tomer. 

To  make  use  of  a  trite  form  of  expression,  it  is  not  the 
use,  but  the  abuse,  of  the  credit  system  that  is  so  costly. 
Among  the  many  who  obtain  credit,  there  are  some  who 
will  not  pay  at  all.  There  are  others  who  will  "dispute" 
their  bills.  There  are  others  from  whom  collection  can 
be  made  only  Avith  difficulty,  and  at  an  expense  which  may 
offset  the  nominal  profit  on  the  transaction,  or  on  several 
transactions. 

There  are  others,  of  the  wealthier  classes,  who  are  too 
proud  to  pay  a  bill  when  it  is  due.  They  defer  payment 
for  much  the  same  reason  that  others  of  their  kind  in  a 
lower  social  stratum  have  goods  charged  instead  of  pay- 
ing cash — they  wish  to  remove  themselves  from  the  class 
of  persons  who  are  suspected  of  being  either  "hard-up" 
or  dishonest  if  they  do  not  pay  promptly.  Their  patron- 
age is  such  an  honor  to  the  tradesman,  they  seem  to  think, 
that  he  should  not  object  to  waiting  a  year  or  more  for 
his  money.  Meanwhile,  the  merchant  may  be  hard-put- 
to-it  to  keep  his  business  going,  and  unable  to  give  his 


S6o  PRINCIPLES  OF  BUSINESS 

other  customers  the  service  which  he  would  Hke  to  give 
them — service  for  which  they  pay,  and  to  which  they  are 
entitled.  His  working  capital  is  tied  up  in  outstanding 
accounts. 

The  customers  who  pay,  pay  not  only  their  own  bills, 
but  the  bills  of  those  who  do  not  pay.  They  pay  also  the 
interest  on  the  overdue  accounts,  and  the  cost  of  collect- 
ing them.  They  pay  for  the  form  letters,  the  postage 
stamps,  the  stenographer's  time,  and  the  repairs  on  the 
collector  s  shoes.  They  pay  for  the  tacks  with  which  the 
sheriff  nails  his  notice  to  the  bankrupt's  door. 

CREDIT    RATINGS 

Who  is  entitled  to  credit? — No  one  is  entitled  to 
credit — personal,  mercantile,  banking,  or  investment — 
unless  he  is  able  and  willing  to  pay  his  debts  at  the  time 
they  are  due.  There  are  three  ratings  which  should  be 
satisfactory  before  any  credit  is  extended — the  moral  rat- 
ing, the  personal-ability  rating,  and  the  financial  rating. 

The  importance  of  the  moral  rating  is  so  obvious  that 
it  need  not  be  enlarged  upon. 

Assuming  that  the  moral  rating  is  satisfactory,  the 
personal-ability  rating  should  be  considered  in  connection 
with  the  financial  rating.  The  obligation  rests  upon  the 
credit  grantor  to  decide  whether  or  not  the  applicant's 
projected  use  of  the  credit  he  desires  is  likely  to  be  profit- 
able, and  whether  or  not  the  applicant  has  a  sufficient 
amount  of  assets  in  reserve  which  he  may  draw  upon  in 
case  more  capital  is  required,  either  to  provide  additional 
financing  for  his  business  or  to  create  a  margin  of  safety 
for  the  security  behind  the  loan. 


CREDIT  561 

It  might  seem  that  if  the  moral  and  financial  ratings 
were  quite  satisfactory  the  credit  grantor  would  not  need 
to  concern  himself  with  the  personal-ability  rating,  but 
this  is  not  the  case.  Even  if  the  applicant  has  a  fund  of 
assets  in  reserve  sufficient  to  assure  the  repayment  of  the 
loan,  the  credit  grantor  has  no  right  to  advance  capital 
which  he  does  not  believe  will  be  used  to  the  benefit  of  the 
applicant  and,  presumably,  to  the  economic  benefit  of 
society.  The  world  has  outgrown  the  theory  that  a 
man's  property  is  his  own,  to  be  used  as  he  pleases.  It 
is  not  possible,  of  course,  for  the  credit  grantor  to  con- 
stitute himself  the  sole  judge  of  the  economic  value  of  an 
undertaking,  and  of  its  probable  success  as  a  business 
venture.  He  should,  however,  ascertain  whatever  he  can 
as  to  the  conditions  which  in  any  given  case  predetermine 
success  or  failure ;  and  while  it  may  be  going  a  little  too 
far  to  say  that  he  should  not  extend  credit  unless  he  is 
convinced  of  success,  he  should  at  any  rate  refuse  credit 
if  he  is  convinced  of  failure,  regardless  of  the  fact  that 
the  applicant  may  have  outside  sources  of  funds  with 
which  he  will  undoubtedly  be  able  to  liquidate  his  obli- 
gation to  the  creditor. 

Specifically,  and  in  common  practice,  however,  the 
basis  upon  which  credit  is  granted  or  refused  is  the  prob- 
ability of  payment  or  of  non-payment  of  the  loan  at  the 
time  it  is  due.  Judgment  as  to  the  probability  of  pay- 
ment is  based  on  a  composite  of  the  applicant's  character, 
personal  ability,  and  financial  condition — ascertained 
from  a  consideration  of  his  reputation,  his  record,  and 
his  financial  statement. 

The  considerations  which  determine  the  amount  of 


562  PRINCIPLES  OF  BUSINESS 

credit  to  be  given  are  very  similar  to  those  which  deter- 
mine whether  or  not  any  credit  shall  be  given,  the  most 
obvious  factors  being  the  personal  ability  and  the  financial 
condition  of  the  applicant — since  it  may  be  taken  for 
granted  that  the  moral  rating  must  be  good,  if  any  credit 
whatever  is  to  be  extended. 

Sources  of  information  regarding  the  credit  appli- 
cant.— In  a  personal  interview  with  the  applicant,  the 
merchant  or  credit  man  can  usually  make  an  excellent 
guess  as  to  the  expediency  of  extending  credit.  Such 
judgments  are  not  safe  to  reply  upon,  however.  Besides, 
many  applications  for  credit  come  from  those  with  whom 
for  some  reason  or  another  a  personal  interview  is  not 
to  be  had.  The  applicant,  perhaps,  may  live  a  thousand 
miles  away.  In  the  world  of  business  dealings,  however, 
as  in  the  world  generally,  something  has  been  invented  to 
meet  every  need.  To  meet  the  need  for  credit  informa- 
tion, agencies  of  several  types  have  arisen.  These  may 
be  classed  as  general  agencies,  special  agencies,  and  mer- 
chants' associations. 

General  agencies. — The  "general"  agencies  are  those 
of  the  Dun  and  Bradstreet  type.  Such  agencies  furnish 
their  subscribers  with  special  reports  on  the  history,  or- 
ganization and  financial  strength  of  any  house  concerning 
which  information  is  desired.  They  also  issue  rating 
books  of  business  men,  firms  and  corporations,  with  capi- 
tal and  credit  ratings.  In  the  rating  books  referred  to, 
a  series  of  letters  or  symbols,  following  the  name  of  the 
person  or  house  in  question,  indicates  the  credit  rating, 
showing  whether  it  is  good,  bad,  or  indifferent,  and  show- 
ing also  the  approximate  amount  of  capital  possessed  by 


CREDIT  563 

the  business.  These  books  of  names  and  ratings  are  sent 
to  subscribers  four  times  a  year.  The  largest  agencies 
hst  approximately  two  million  names.  Besides  the  com- 
plete Hst,  State  editions  are  also  pubhshed.  A  few  agen- 
cies make  a  special  point  of  reporting  on  personal  his- 
tories of  individuals. 

Special  agencies. — In  addition  to  the  general  agencies, 
of  the  Dun  and  Bradstreet  type,  special  agencies  have 
made  their  services  available  for  the  merchant,  such  an 
agency  devoting  its  entire  attention  to  particular  lines  of 
business;  one  may  specialize  on  shoe  stores,  another  on 
hardware  dealers,  and  so  on. 

Merchants'  associations. — One  of  the  most-used 
sources  of  credit  information  is  the  file  of  credit  reports 
compiled  by  merchants"  associations.  Thus  we  find, 
among  retailers,  that  each  town  of  any  size  has  its  "retail 
merchants'  association,"  which  is  usually  affiliated  with 
State  and  national  organizations.  When  a  new  customer 
asks  for  credit,  the  storekeeper  calls  up  the  local  office  of 
the  association  and  asks  for  information  concerning  the 
applicant.  If  the  appHcant  has  just  "moved"  from  an- 
other city,  the  secretary  of  the  association  gets  a  report 
on  him  from  the  association  in  the  city  of  his  previous 
residence.  Likewise  among  jobbers  and  manufacturers, 
each  industry  has  its  association.  However  fiercely  the 
members  may  compete  against  each  other,  they  are  united 
against  the  rest  of  the  world,  especially  in  protecting 
themselves  against  "bad-pay"  customers,  or  against  un- 
desirable legislation.  Thus  members  of  an  association 
of  shoe  manufacturers  will  freely  give  information  to 
each  other  as  to  the  habits  of  their  customers — whether  or 


564  PRINCIPLES  OF  BUSINESS 

not  they  pay  their  bills — whether  or  not  they  return  goods 
which  should  be  kept  and  paid  for,  and  the  like. 

Information  from  salesmen. — Another  source  of 
credit  information  which  the  merchant  should  constantly 
draw  upon  is  the  knowledge  possessed  by  his  own  sales- 
men. The  salesman  comes  in  personal  contact  not  only 
with  the  customers  of  the  house,  but  also  with  competi- 
tors of  those  customers,  as  well  as  with  the  salesmen  of 
other  houses.  Of  course,  it  is  understood  that  the  mer- 
chant will  not  permit  his  salesmen  to  make  themselves 
conspicuous,  or  obnoxious  to  customers  or  competitors, 
by  prying  into  'other  people's  business,"  but  the  knowl- 
edge a  salesman  "picks  up"  legitimately  should  be  con- 
sidered the  property  of  the  house,  to  be  turned  in  at  every 
visit  to  headquarters,  or,  if  important,  to  be  transmitted 
by  letter  or  by  wire. 

Information  from  banks. — Especially  before  extend- 
ing a  large  amount  of  credit  to  a  customer,  the  merchant 
would  do  well  to  ask  his  own  banker  for  a  report  on  the 
customer.  Bankers,  through  their  affiliations  with  other 
banks,  are  often  in  a  position  to  obtain  for  a  merchant 
valuable  information  concerning  the  financial  condition 
of  his  customers. 

Information  from  the  applicant  himself. — Again,  be- 
fore extending  a  considerable  amount  of  credit  to  a  cus- 
tomer, the  merchant  should  ask  for  a  financial  statement 
— that  is,  a  statement  of  the  applicant's  assets  and  liabili- 
ties. If  the  customer  is  in  good  financial  condition,  he 
will  be  glad  of  the  opportunity  to  give  such  a  statement; 
if  he  is  not,  the  merchant  should,  of  course,  regard  the 
refusal  to  furnish  a  statement  as  a  sufficient  warning. 


CREDIT  5(35 

The  statement,  when  obtained,  should  be  carefully  ana- 
lyzed— it  may  contain  elements  of  weakness  not  suspected 
even  by  the  customer  himself.  The  analysis  of  financial 
statements  is  considered  at  some  length  in  the  chapter  on 
the  subject  of  "Financial  Statements." 

Information  from  attorneys. — For  the  securing  of  in- 
formation concerning  the  standing  of  an  applicant,  espe- 
cially of  one  in  a  distant  place,  an  attorney  in  the  town 
of  the  debtor's  residence  is  often  useful.  Attorneys  are 
likely  to  be  aware  of  litigation  in  which  the  customer 
may  be  or  may  have  been  involved,  and  they  usually  know 
whether  a  man's  reputation  is  "good"  or  "bad."  Lists 
of  attorneys  in  all  parts  of  the  country  are  to  be  had  from 
certain  publishers,  and  by  writing  to  the  listed  attorney 
at  the  place  where  the  applicant  resides  the  merchant  can 
secure  information  which  may  be  of  value.  Such  infor- 
mation cannot  always  be  relied  upon,  however,  as  the 
corresponding  attorney  may  be  prejudiced,  or  for  per- 
sonal reasons  may  give  an  inaccurate  or  incomplete  re- 
port. 

Information  from  credit  men's  associations. — • 
Closely  allied  with  the  work  of  the  merchants'  associa- 
tions, previously  mentioned,  is  that  of  the  credit  men  of 
the  country.  Every  firm  and  corporation  of  importance 
has  its  "credit  man" — a  specialist — who  devotes  his  entire 
time  to  the  problems  of  extending  credit  and  "getting  the 
money"  after  credit  has  been  extended.  These  credit 
men  have  their  own  associations,  local  and  national,  and 
maintain  bureaus  for  the  gathering  and  distribution  of 
credit  information;  the  principal  such  association  is  the 
National  Association  of  Credit  Men. 


566  PRINCIPLES  OF  BUSINESS 

COLLECTIONS 

Requirements  of  a  collections  system. — Every  busi- 
ness should  have  a  "system"  for  making  collections — a 
system  which  will  not  only  take  care  of  ordinary  collec- 
tions in 'the  regular  course  of  business,  but  which  will 
apply  as  a  matter  of  routine  the  best  methods  for  making 
collections  from  slow-pay  customers.  Customers  who  do 
not  pay  promptly  are  usually  classed  somewhat  as  fol- 
lows: (i)  Good,  but  slow;  (2)  "Dead-beats;"  (3)  Un- 
fortunate. The  system  should  be  adapted  for  using  dif- 
ferent methods  with  each  of  these  three  classes. 

The  "tickler"  system. — A  bill,  of  course,  should  al- 
ways be  sent  with  the  goods.  The  best  practice  is  to  let 
this  bill  inform  the  customer  of  the  date  upon  which  pay- 
ment is  expected.  In  the  so-called  "tickler  system,"  a 
copy  of  the  bill  is  made  on  a  card  and  the  card  is  placed 
in  the  "tickler  file,"  where  it  will  come  up  for  attention 
upon  the  date  it  is  due.  Upon  that  date  another  bill  is 
sent  to  the  customer,  and  the  card  is  advanced  a  reason- 
able distance  ahead.  When  it  comes  up  again,  the  credit 
man  ascertains  whether  the  bill  has  been  paid  or  not,  and, 
if  not,  mails  another  bill  with  a  polite  request  for  pay- 
ment. With  such  a  system  as  this,  no  account  is 
neglected,  or  what  may  be  as  bad,  disturbed  too  soon. 
Nothing  seems  to  anger  a  customer  more  easily  than  a 
request  for  payment  earlier  than  at  the  time  agreed  upon. 
If,  for  instance,  the  customer  asks  for  an  extension  till 
a  given  date,  the  card  will  be  advanced  to  a  reasonable 
distance  beyond  the  date  agreed  upon,  and  there  the 
matter  rests  until  the  card  brings  it  again  to  the  attention 
of  the  credit  man.     In  connection  with  this  system,  vari- 


CREDIT  567 

ous  means  of  urging  or  enforcing  payment  are  employed. 
Requests  become  more  pointed,  drafts  upon  the  customer 
may  be  made  through  the  merchant's  bank,  the  account 
may  be  turned  over  to  a  collection  agency,  or,  finally,  legal 
steps  may  be  taken  to  compel  payment. 

Dealt  with  by  means  of  such  a  collection  system  as  this, 
the  "good  but  slow"  class  of  customers  will  probably  have 
paid  before  any  unfriendly  action  is  taken. 

Collection  from  "slow-pay"  customers. — It  may  be 
said  that  for  the  customer  seeking  merely  to  avoid  pay- 
ment, no  course  is  too  severe.  Subsequent  sales  to  such 
a  customer  are  not  to  be  made,  and  the  only  consideration 
is  to  get  the  money,  by  any  means  possible,  as  quickly  as 
possible. 

The  remaining  class,  composed  of  those  who  would  like 
to  pay  but  are  unable,  on  account  of  misfortune,  to  do  so, 
are  to  be  dealt  with  in  an  entirely  different  spirit.  The 
merchant  will  give  them  every  assistance  he  can,  in  the 
way  of  extending  the  time  for  payment,  or  even,  in  ex- 
treme cases,  by  lending  them  money,  goods,  or  credit,  so 
that  they  may  regain  their  business  footing  and  again  be- 
come valued  customers  of  the  house. 

Before  the  merchant  can  decide  what  course  is  wisest 
for  the  interests  of  his  customer  and  also  his  own,  he 
must  secure  a  frank  statement  of  the  customer's  condi- 
tion. If  the  customer's  character  and  business  ability  are 
good,  and  if  all  he  really  seems  to  need  is  more  capital, 
the  merchant  will  endeavor  to  help  him  to  strengthen  or 
re-establish  his  business.  If,  however,  he  is  seen  to  be 
lacking  in  ability,  even  though  his  intentions  be  of  the 
best,  the  wisest  course  may  be  to  file  a  bankruptcy  peti- 


568  PRINCIPLES  OF  BUSINESS 

tion  and  let  the  creditors  get  what  they  can  out  of  his 
assets  before  they  are  further  diminished,  and  before  the 
more  insistent  creditors  are  paid  at  the  expense  of  the  more 
patient.  In  many  cases,  however,  a  business  is  thrown 
into  the  bankruptcy  courts  by  the  ill-considered  and  hos- 
tile action  of  only  a  few  of  the  creditors.  Even  after  the 
filing  of  a  bankruptcy  petition  it  is  not  impossible  for  the 
creditors  to  come  to  an  agreement  with  the  bankrupt, 
under  which  he  pays  a  certain  proportion  of  his  debts, 
equitably  to  each  creditor.  Such  an  agreement  is  called 
a  "composition  in  bankruptcy."  It  is  better  for  all  con- 
cerned, however,  if  a  similar  agreement,  called  a  "com- 
position settlement,"  can  be  made  before  a  bankruptcy 
petition  has  been  filed.  If  a  petition  is  filed  and  the  debtor 
is  adjudged  bankrupt,  and  if  no  composition  or  adjust- 
ment is  made,  the  property  of  the  debtor  is  sold  by  a 
"trustee"  elected  by  the  creditors,  and  the  proceeds  are 
divided  equitably  among  the  creditors,  after  which  the 
bankrupt  is  "discharged,"  free  of  all  debts.  If  he  has 
justly  owed  the  debts,  however,  and  is  an  honest  man,  he 
will  eventually  repay  his  creditors  in  full,  although  they 
can  have  no  further  legal  claim  upon  his  property. 

CREDIT  SAFEGUARDS 

The  credit  guaranty. — The  merchant  who  is  doubtful 
of  the  credit  applicant's  ability  or  inclination  to  pay  will 
often,  before  extending  credit,  require  him  to  have  the  pay- 
ment of  the  account  guaranteed  by  some  responsible  per- 
son. Such  guarantees  may  be  general — addressed  to  the 
public — or  they  may  be  special,  covering  a  single  pur- 
chase, or  successive  purchases,   from  a  single  creditor. 


CREDIT  569 

Such  a  guarantee  must  be  in  writing,  and  any  change 
made  in  the  terms  of  sale  between  merchant  and  customer 
without  the  guarantor's  consent  makes  void  the  guar- 
antee. An  extension  of  time  for  payment  would  be  such 
an  alteration,  for  instance.  In  some  forms  of  guarantee, 
such  as  that  recommended  by  the  National  Association  of 
Credit  Men,  the  guarantor  waives  notice  of  change  in 
terms  of  sale,  so  that  the  guarantee  is  binding  even  where 
extensions  are  granted  without  consent  of  the  guarantor. 
The  guarantee  may  be  terminated  at  any  time  by  the 
guarantor,  but  he  is,  of  course,  liable  for  the  payment  of 
any  debts  already  incurred. 

Credit  insurance. — A  method  of  protection  against 
extraordinary  losses  from  bad  debts  is  the  use  of  "credit 
insurance."  Briefly  described,  credit  insurance  is  insur- 
ance which  reimburses  the  policy  holder  for  bad-debt 
losses.  It  does  not  cover,  however,  all  losses  up  to  the 
face  amount  of  the  policy.  The  merchant  ordinarily 
loses  a  certain  proportion  of  his  accounts.  This  normal 
or  expected  loss  is  not  protected,  but  is  deducted  from  the 
face  amount  of  the  policy  when  settlement  is  made.  For 
the  purpose  of  the  credit-insurance  policy  this  normal 
loss,  called  the  "initial  loss,"  is  the  average  of  the  mer- 
chant's losses  for  the  five  years  preceding  the  taking  out 
of  the  policy,  or  if  the  merchant  has  been  in  the  business 
less  than  five  years,  the  average  amount  of  his  credit 
losses  while  he  has  been  in  the  business.  Obviously,  there 
would  be  no  advantage  in  the  protection,  by  insurance, 
of  the  "expected"'  or  normal  bad-debt  loss,  because  an 
amount  equal  to  this  loss  would  unavoidably  be  added 
to  the  cost  of  the  policy. 


570  PRINCIPLES   OF   BUSINESS 

The  justification  of  any  insurance  business,  which  is  a 
costly  one,  requiring  expert  services  that  could  well  be 
utilized  in  more  "productive"  fields,  is  in  that  it  is  a  means 
of  distributing  the  business  risk.  Insurance,  in  reality,  is 
only  a  shock  absorber  for  business.  It  is  doubtful,  how- 
ever, if  there  is  this  justification  for  credit  insurance,  as 
the  merchant's  credit-risks  are  usually  fairly  well  dis- 
tributed. By  1)uilding  up  a  reserve  for  bad-debt  losses, 
the  merchant  can  provide  himself  with  a  "shock  absorber"' 
which  is  cheaper  than  credit-insurance. 

The  credit  man. — To  find  and  correct  troubles  at  their 
source  is  the  best  way  to  deal  with  them.  To  prevent 
collection  troubles  from  materializing — to  avoid  extend- 
ing credit  to  those  who  are  not  entitled  to  credit — should 
be  the  business  man's  policy,  more  satisfactory  than  a 
credit-insurance  policy  and  less  expensive.  The  small 
merchant  must  learn  the  principles  of  credit-granting  for 
himself ;  the  larger  establishment  will  make  use  of  the 
highly  trained  and  highly  sensitive  credit  man,  whose 
duties  tend  more  and  more  to  become  those  of  a  specialist. 
The  thoroughgoing  credit  man,  in  order  that  he  may  be 
able  to  grant  the  right  amount  of  credit  in  individual 
cases,  must  have  not  only  the  skill  to  analyze  financial 
statements  and  to  use  the  various  sources  of  credit  infor- 
mation, with  respect  to  each  particular  applicant,  but  also 
to  interpret  the  larger  movements  in  the  world  of  indus- 
try. Especially  must  he  be  skilled  in  the  "barometrics  of 
business,"  understanding  the  significance  of  such  indica- 
tors of  business  condition  as  bank  clearings  and  the  ratio 
of  reserves  to  deposits. 

It  is  largely  upon  the  credit  man  that  the  duty  devolves 


CREDIT  571 

of  adjusting  the  load-factor  of  the  individual  business  in 
its  proper  relation  to  the  carrying  capacity  of  business  as 
a  whole ;  for  the  amount  of  credit  extended,  and  the  pur- 
poses for  which  it  is  extended,  determine  directly  the  na- 
ture and  extent  of  production,  which,  obviously,  should 
be  adjusted  to  the  consumers'  needs,  and  as  far  in  advance 
of  these  needs  as  may  be  possible,  so  that  if  the  needs 
should  change,  or  should  prove  to  have  been  estimated 
incorrectly,  production  may  be  diverted  into  the  proper 
economic  channels  before  a  waste  ensues.  Such  a  main- 
taining of  the  ''balance"  of  business  activities  is  a  proper 
function  of  the  credit  man. 

BIBLIOGRAPHY 

Ettinger  and  Golieb,  Credits  and  Collections. 
Gardner,  E.  H.,  New  Collection  Methods. 
Prendergast,  W.  A.,  Credit  and  Its  Uses. 
Blanton,  B,  H.,  Credit,  Its  Principles  and  Practice. 
Hagerty,  J.  E.,  Mercantile  Credit. 
Gerstenberg,  C.  W.,  Tlie  Law  of  Bankruptcy. 
National  Association  of  Credit  Men,  Annual  Diary. 
National  Association  of  Credit  Men,  Bulletin. 
Wall,  Alexander,   The  Bankers'  Credit  Manual. 
Lawrence,   Henry   C,   Cash  Discount  Piracy. 


CHAPTER    XXV 

FORECASTING  BUSINESS  CONDITIONS 

The  importance  of  business  forecasting. — Every 
business  man  is  more  or  less  of  a  speculator.  Even  the 
humble  cobbler,  who  comes  as  near  to  the  wage,  earner  as 
any  independent  enterpriser  can  come,  speculates  to  a 
certain  extent.  He  buys  his  sole  leather  and  his  rubber 
heels,  his  polishing  material  and  his  thread  in  quantities 
more  than  sufficient  to  last  him  for  a  day,  and  though 
his  purchases  are  for  convenience  and  not  for  taking  ad- 
vantage of  price  changes,  he  will  get  these  advantages, 
or  conversely  lose  them,  if  prices  go  up  or  come  down. 
To  the  extent  that  he  consciously  takes  advantage  of  the 
probable  changes  in  prices  he  consciously  attempts  to 
seize  one  of  the  important  sources  of  profits.  Indeed,  as 
the  economists  point  out,  if  our  competition  system 
worked  out  smoothly,  the  cobbler  would  get  no  profits  at 
all — he  would  simply  earn  a  fair  wage  for  himself.  And 
the  same  thing  would  be  true  in  more  complex  businesses 
— if  the  competition  system  worked  with  absolute  pre- 
cision, and  if  employees,  capitalists  and  laborers  all  knew 
where  their  best  opportunities  lay,  and  promptly  seized 
them,  the  enterpriser  would  make  no  profits.  The  busi- 
ness man  who,  in  our  imperfect  system,  where  price 
changes  are  constantly  taking  place,  can  estimate  supply 
and  demand  and  who  has  the  ability  to  govern  his  activi- 

572 


BUSINESS  FORECASTING  573 

ties  according  to  his  estimates  is  the  profit  maker.^  The 
business  man  who  would  be  successful  should  not  let  too 
much  of  his  business  rest  on  chance  or  on  the  conclusions 
of  a  slightly-informed  judgment.  Purchases  should  be 
made  with  a  reasonable  knowledge  of  what  prices  will  be 
obtainable  for  the  products  into  which  the  purchased  ma- 
terials will  enter  and  credit  should  be  granted  to  those 
whose  purchases  are  made  on  a  safe  basis  of  pre-informa- 
tion. 

But  the  value  of  a  business  barometer  that  could  tell 
us  whether  to  expect  an  increase  or  decrease  in  business 
activity  extends  to  other  business  men  than  manufac- 
turers and  dealers.  "Government  officials  need  a  ba- 
rometer when  handling  the  problem  of  unemployment  or 
when  considering  the  advisability  of  inaugurating  large 
government  undertakings ;  *  *  *  bankers  need  a  business 
barometer  to  guide  them  in  extending  or  calling  their 
loans  and  discounts;  and  investors  need  one  to  direct 
their  purchases  and  sales  of  securities."  - 

Barometers. — A  barometer  is  an  instrument  for  meas- 
uring atmospheric  pressure  and  is  used  for  forecasting 
weather.  We  know  by  experience  that  a  "falling  ba- 
rometer" caused  by  a  decrease  in  atmospheric  pressure 
precedes  a  storm,  that  a  "rising  barometer"  indicates  the 
approach  of  fair  weather  and  that  a  steady  barometer  in- 
dicates settled  fair  weather. 

Business  cycles. — Business  has  its  storms  and  fair 

1  Any  modern  text  on  economics  may  be  consulted  for  the  theory 
of  profits.     See,  for  example,  Ely's  Outlines  of  Economics,  Chap. 

XXV. 

-  Warren   M.   Persons,  "Construction  of  a  Business  Barometer," 
American  Economic  Review,  Vol.  vi,  p.  739. 


574  PRINCIPLES  OF  BUSINESS 

weather.  These  storms  and  periods  of  fair  weather  can 
be  traced  to  causes  that  act  with  the  same  effectiveness 
as  changes  in  the  atmospheric  pressure.  We  may  start 
with  fair  weather — with  business  making  fair  progress. 
Prices  rise.  "Rising  prices  put  money  into  the  pockets 
of  producers  and  those  who  are  responsible  for  keeping 
the  wheels  of  industry  spmning."  ^  This  is  the  first 
stage  of  the  business  cycle  and  we  may  call  it  the  period 
of  improvement.  It  naturally  develops  into  the  second 
stage,  the  period  of  prosperity.  Money  is  invested  in 
fixed  assets,  such  as  plants  and  machines,  with  the  intent 
of  sharing  in  the  general  prosperity.  Loans  are  freely 
made,  especially  on  collateral  whose  value  is  constantly 
increasing.  This  process  of  "pyramiding"  loans  soon 
carries  the  business  world  beyond  the  point  where  values 
can  be  justified  by  earning  power.  Some  large  concern 
fails  to  pay  interest  on  its  loans,  and  the  various  concerns 
with  which  it  has  been  dealing, .  unable  to  collect  the 
moneys  upon  which  they  relied  to  discharge  their  own 
obligations,  default  on  some  of  their  debts.  Banks  be- 
come suspicious  and  call  loans.  In  order  to  meet  the  call, 
borrowers  sell  securities  and  the  selling  increases  the 
supply  on  the  market  sufficiently  to  depress  stock-market 
prices.  Margins  disappear  and  more  securities  are  sold. 
Values  tumble.  There  is  a  panic  and  we  find  ourselves 
in  the  third  stage,  out  of  which  we  gradually  emerge  into 
the  fourth  stage,  the  period  of  depression  in  which  re- 
adjustments are  made  and  the  business  world  gets  ready 
to  start  the  cycle  over  again. 

It  will  be  seen  that  these  periods  succeed  each  other  as 

1  Hartley  Withers,  The  Business  of  Finance,  p.  49. 


BUSINESS  FORECASTING  575 

a  result  of  changes  in  the  credit  situation.  When  credit 
is  expanding,  prices  rise,  since  credit  really  increases  the 
supply  of  money,  and  money  really  becomes  cheap  in 
relation  to  commodities.  The  panic  follows  the  period 
of  prosperity,  because  we  tend  to  overextend  credit,  to 
give  credit  to  people  because  they  have  property  which  we 
value  at  amounts  larger  than  is  warranted  by  the  earning 
power  of  the  property.  The  panic  period  contracts  credit 
abnormally.  It  is  a  psychological  reaction  from  the 
overconfidence  of  the  period  of  prosperity,  and  business 
men  generally  do  not  recognize  the  credit  of  members  of 
the  business  world  to  the  extent  to  which  they  are,  by 
virtue  of  their  property  and  its  earning  power,  entitled. 
Gradually,  fear  is  overcome  during  the  period  of  depres- 
sion and  as  credit  is  more  freely  recognized  we  again 
enter  upon  the  period  of  improvement. 

Studying  fundamental  business  conditions. — Since 
conditions  change  and  since  a  large  part  of  the  profits  of 
business  arise  out  of  these  changes,  it  behooves  the  busi- 
ness man  to  foresee  as  far  as  possible  when  tliese  changes 
are  likely  to  take  place,  the  direction  they  will  take,  and 
the  extent  to  which  they  will  go.  Not  many  years  ago 
foresight  was  largely  a  matter  of  intuition.  Men  had 
"hunches."  Perhaps  this  intuition  was  unconsciously 
guided  by  information,  but  there  was  little  conscious 
effort  to  collect  all  the  available  information  and  to  make 
the  data  thus  collected  the  basis  of  reasonable  judgment. 
Nowadays,  such  data  are  collected  and  are  used  for  fore- 
casting business  weather  conditions.  The  materials 
available  may  be  used  in  their  crude  form  or  they  may  be 
statistically  worked  up  into  a  so-called  barometer.     Thus 


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578  PRINCIPLES  OF  BUSINESS 

we  may  see  stock-market  prices  rising  and  this  we  take 
as  a  sign  of  improving  business.  But  if  at  the  same  time 
bank  clearings  are  decreasing  in  amount  there  is  an  in- 
dication that  business  is  not  improving,  and  one  who  sees 
these  two  facts  happening  at  the  same  time — increasing 
stock  prices  and  decreasing  bank  clearings — will  have  to 
judge  which  is  the  better  indicator  of  the  trend  of  busi- 
ness. If,  however,  these  two  facts — or  series  of  facts,  if 
we  take  the  figures  day  by  day — can  be  combined  in  some 
way,  we  get  a  "business  barometer"  which  will  indicate 
changes  for  the  better  or  for  the  worse. 

Possibility  of  accurate  forecasting. — Business  fore- 
casting with  absolute  accuracy  will  never  be  possible.  The 
outcome  of  many  forces  over  which  man  has  no  control, 
such  as  the  relation  of  climatic  conditions  to  the  agricul- 
tural productivity  of  the  country,  will  always  be  uncertain. 
But  the  major  trend  of  economic  conditions  can  always  be 
foreseen  in  time  to  avert  industrial  disaster  if  basic  eco- 
nomic laws  are  known.  "The  forces  that  primarily  cause 
the  alternation  of  boom  and  depression  can  be  regulated, 
once  they  are  understood.  The  severity  of  these  ups  and 
downs  is  due  in  large  measure  to  the  lack  of  adequate  fore- 
sight, lack  of  general  appreciation  of. the  factors  that  in- 
fluence the  course  of  business  prosperity,  and  failure  to 
adopt  corrective  policies  in  season."  ^ 

In  fact,  there  is  no  doubt  in  the  minds  of  those  inter- 
ested in  the  subject  of  business  forecasting  but  that  the 
dangers  attendant  upon  periods  of  business  depression 
can   be   largely  eliminated   by   intelligent   study.      While 

^  Prof.  M.  T.  Copcland  in  address  at  First  Federal  Conference  on 
Business  Conditions  Reporting. 


BUSINESS  FORECASTING  579 

business  forecasting  with  absolute  accuracy  may  never  be 
possible,  still,  the  same  scientific  procedure  which  has  been 
used  so  successfully  in  other  fields — say  engineering  and 
medicine — ought  to  be  equally  valuable  in  the  realm  of 
business  and  economics. 

The  basis  of  intelligent  forecasting. — The  basis  of  all 
intelligent  forecasting  is  to  be  found  in  what  is  known  in 
mathematics  as  the  law  of  causality.  This  law  holds  that 
everything  which  happens  necessarily  happens  as  the  con- 
sequence of  a  previous  state  of  things.  In  order  to  pre- 
determine what  is  to  happen,  one  must  be  fully  acquainted 
wath  what  is  happening.  Commerce  is  continuous,  and 
the  stream  which  flows  by  to-day  had  its  origin  in  the 
springs  of  yesterday.  The  problem  of  successful  foi"e- 
casting  is  entirely  a  matter  of  properly  appraising  existing 
forces. 

How  business  conditions  are  measured. — While 
business  conditions  may  not  always  be  measured  in  statis- 
tical units,  there  is  no  better  way  to  ascertain  facts  which 
enable  the  establishment  of  an  opinion  as  to  the  trend  of 
business.  The  field  of  commerce  embraces  the  two  major 
functions  of  production  and  distribution,  subordinate  to 
which  we  have  labor  conditions,  business  profits,  the  ex- 
changes, and  the  money  market.  The  activity  of  business 
may  be  measured  from  changing  conditions  in  each  of 
these  fields. 

Barometers  of  production. — Production  may  logi- 
cally be  divided  into  two  fields,  namely,  agricultural  and 
industrial. 

Agricultural  production  is  the  greatest  single  factor 
which  influences  changes  in  business  conditions.     Good 


58o  PRINCIPLES  OF  BUSINESS 

crops  usually  bring  prosperity  because  they  determine 
(i)  the  purchasing  power  of  the  farming  class  directly, 
(2)  the  purchasing  power  of  the  industrial  workers  in- 
directly, and  (3)  the  earning  power  of  the  railroads  and 
other  carriers.  The  harvests  are  large  or  small  as  climatic 
conditions  are  favorable  or  unfavorable;  and  the  farmers 
have  no  control  over  these  conditions. 

Industrial  production  is  regulated  largely  in  accordance 
with  the  harvests,  past  and  prospective.  The  following 
indices  are  used  to  determine  the  trend  of  industrial  pro- 
duction : 

(a)  the  production  of  pig-iron; 

(b)  the  unfilled  orders  of  the  United  States  Steel  Cor- 
poration ; 

(c)  the  production  of  copper; 

(d)  the  production  of  bituminous  coal; 

(e)  the  production  of  petroleum; 

(f)  the  volume   of   new  building,    from   the  permits 
granted  and  contracts  awarded  in  leading  centers. 

The  production  of  pig-iron  has  long  been  regarded  as 
one  of  the  best  indices  of  current  activity.  This  is  be- 
cause iron  and  steel  are  the  basic  products  of  industry. 

Barometers  of  distribution. — Distribution  may  be  di- 
vided into  two  fields,  namely,  transportation  and  market- 
ing. 

The  activity  of  the  steam  railroads  of  the  country  in  the 
transportation  of  freight  is  regarded  as  a  good  index  of 
conditions.  The  traditional  way  of  measuring  railroad 
activity  through  the  number  of  idle  cars  and  gross  rev- 
enues has  been  superseded  by  the  better  plan  of  compiling 


BUSINESS  FORECASTING  581 

records  which  show  the  number  of  freight  cars  loaded 
weekly. 

]\Iarketing  activity  may  be  gauged  from  the  trend  of 
prices,  and  from  the  volume  of  foreign  and  domestic  trade. 

The  trend  of  price  levels  is  a  most  important  factor  in 
business  barometrics.  Rising  prices  encourage  trade  just 
as  falling  prices  have  the  opposite  tendency.  Price  levels 
are  measured  by  index  numbers  which  are  usually  com- 
piled monthly.  The  U.  S.  Department  of  Labor  Index 
Number  of  Wholesale  Prices  for  the  month  of  June,  1922, 
was  150,  which  compared  with  a  base  of  100  for  the  year 
191 3.  This  would  indicate  that  the  general  level  of  prices 
in  June,  1922,  was  50  per  cent  higher  than  in  191 3. 

The  value  of  exports  and  imports,  especially  in  our 
trade  with  Europe,  is  regarded  as  a  valuable  criterion  of 
present  and  future  conditions.  Less  valuable,  perhaps,  are 
the  compilations  which  show  the  trade  changes  in  the 
large  retail  stores  of  the  country. 

Barometers  of  'labor  conditions. — Statistics  which 
show  the  number  of  persons  employed,  and  the  wages  re- 
ceived, at  representative  industrial  plants  are  now  being 
compiled.  These  tables  are  of  distinct  value  for  baro- 
metric purposes.  The  number  of  immigrant  arrivals  is  no 
longer  regarded  as  an  important  factor  because  of  the  re- 
strictive legislation  which  is  now  in  effect. 

Barometers  of  business  profits. — The  published  re- 
ports of  the  earnings  of  the  large  corporations  have  a  cer- 
tain barometric  value  which,  however,  is  largely  nullified 
by  the  slowness  with  which  the  information  becomes 
available. 

The  number  of  commercial  failures  is  an  especially  good 


582  PRINCIPLES  OF  BUSINESS 

index.  Failures  are  few  in  periods  of  prosperity  and 
numerous  in  times  of  depression.  It  is  peculiar  but  true 
that  a  very  low  number  of  failures  indicates  danger  in 
the  form  of  a  business  relapse  which  is  about  to  occur. 

Barometers  of  the  exchanges. — Because  the  operators 
on  the  various  exchanges  of  the  country  are  constantly 
endeavoring  to  discount  the  future,  the  movement  of 
prices  thereon  is  supposed  to  foreshadow  the  trend  of 
business  conditions.  In  times  of  depression,  stock  prices 
rise  before  conditions  improve  and  in  times  of  prosperity, 
stock  prices  usually  recede  before  the  height  of  the  boom 
is  reached. 

The  movement  of  prices  on  the  commodity  exchanges, 
for  example,  those  of  wheat,  corn,  cotton,  iron,  copper, 
and  wool,  is  regarded  as  highly  significant,  since  price- 
changes  occur  first  on  the  raw  materials  of  commerce  be- 
fore reaching  the  finished  products. 

Barometers  of  the  money  market. — The  volume  of 
bank  clearings,  that  is,  the  checks  handled  by  local  clear- 
ing associations,  is  now  regarded  as  being  less  valuable 
from  a  barometric  standpoint  than  the  volume  of  bank 
debits,  that  is,  the  total  charges  made  against  accounts  at 
the  leading  banks. 

Bank  statements,  which  reflect  the  condition  of  the  lead- 
ing banks,  especially  the  Federal  Reserve  system,  are  now 
regarded  as  being  among  the  very  best  indices  of  current 
conditions.  The  condition  of  the  banks  shows  the  avail- 
ability of  credit  in  the  country.  The  extent  to  which  loans 
may  be  obtainable  has  always  been  a  potent  influence  upon 
the  trend  of  conditions. 

The  current  interest  rate,  or  the  cost  of  borrowing,  is 


BUSINESS  FORECASTING  583 

likewise  a  good  index  of  conditions  in  the  money  market. 
A  low  interest  rate  reflects  easy  conditions  and  a  rather 
inactive  industrial  situation.  A  high  rate  indicates  both 
money  stringency  and  industrial  activity. 

Composite  barometers. — Seldom  indeed,  if  ever,  do 
all  the  barometers  of  business  register  uniformly.  Pig- 
iron  production  during  the  last  half  of  1920  continued  at 
a  high  rate  although  a  distinct  industrial  depression  began 
the  same  summer.  Moreover,  no  single  one  of  the  busi- 
ness barometers  is  infallible.  The  "shadow  which  is  cast 
before"  must  be  sought  as  a  result  of  considering  more, 
than  one  index  of  conditions. 

The  problem  of  constructing  a  single  barometer  of  busi- 
ness based  upon  the  various  indicia  available  is  most  diffi- 
cult. It  has  yet  to  be  solved  in  a  manner  generally  accept- 
able. In  a  professional  w^ay,  the  Babson,  the  Brookmire, 
and  the  Harvard  University  charts  endeavor  to  accom- 
plish this  objective. 

Bibliography  of  forecasting. — The  number  of  books 
published  on  this  subject  is  decidedly  limited.  Professor 
W.  C.  Mitchell's  Business  Cycles,  published  in  1914,  re- 
mains the  most  thorough  work  of  its  kind.  Professor  D. 
F.  Jordan's  Business  Forecasting  has  been  used  for  much 
of  the  material  in  this  chapter.  R.  W.  Babson's  Business 
Barometers  contains  many  indicia  in  addition  to  those 
mentioned  herein. 

The  Surz'ey  of  Current  Business,  published  monthly  by 
the  Department  of  Commerce,  is  an  invaluable  source  of 
information.  The  Federal  Reserve  Bulletin,  published 
monthly  by  the  Federal  Reserve  Board,  also  contains  much 
valuable  statistical  information. 


584  PRINCIPLES  OF  BUSINESS 

Other  books  include  :  C,  A.  Juglar,  A  Brief  History  of 
Panics  in  the  United  States;  T.  E.  Burton,  Crises  and 
Depressions;  E.  D.  Jones,  Economic  Crises;  and  the  pub- 
Hcations  of  the  Harvard  University  Committee  on  Eco- 
nomic Research. 


CHAPTER    XXVI 

BANKING 

BUSINESS  AND  ECONOMIC  SERVICES  OF  BANKS 

What  banks  are  for. — The  prime  function  of  banks 
is  to  transmute  credit  into  an  exchangeable  form ;  to  pro- 
vide means  and  faciHties  for  the  exchange  of  credit  for 
other  credit,  money,  or  goods;  and  further,  to  adjust  the 
amount  and  distribution  of  business  credit  to  current 
needs  or,  more  precisely,  to  current  demand.  Almost 
the  entire  business  of  the  country  is  done  on  "credit" 
of  one  form  or  another,  even  most  of  the  currency  which 
passes  from  hand  to  hand  being  no  more  than  subdivi- 
sions of  the  credit  of  the  Government  or  of  the  issuing 
bank. 

Incidentally,  banks  perform  a  number  of  other  useful 
services,  such  as  safekeeping  of  mone}^  and  other  val- 
uables, but  their  activities  outside  of  those  implied  in 
the  foregoing  paragraph  are  of  minor  interest. 

Public  credit  and  private  credit. — Credit  is  of-  two 
general  kinds — public  credit  and  private  credit.  While 
the  services  of  banks  with  respect,  to  the  handling  of 
government  and  municipal  bonds  and  other  instruments 
representing  public  credit  are  of  very  great  importance, 
and  are  furthermore  very  closely  connected  with  those 
of  their  transactions  which  have  to  do  primarily  with 
private  credit,  wc  must  take  their  public-credit  services 

585 


586  PRINCIPLES  OF  BUSINESS 

for  granted,  and  confine  our  present  examination  of 
banking  functions  to  those  which  are  concerned  primarily 
with  private  credit,  and  more  especially,  with  that  phase 
of  private  credit  which  is  known  as  business  credit. 

It  may  be  noted,  however,  that  public  credit  and  pri- 
vate credit  each  are  supported  by  the  same  assets,  upon 
which  the  holders  of  public-credit  instruments  have  a 
prior  claim,  although  it  is  very  rarely  that  such  holders 
themselves,  in  the  satisfaction  of  their  claims,  proceed 
directly  upon  the  mortgaged  assets,  if  such  there  are. 
The  government  or  municipality,  by  a  levy  of  taxes, 
secures  funds  with  which  to  meet  its  obligations,  and 
may  foreclose  on  the  property  of  individuals  within  the 
indebted  tax  district  in  order  to  secure  from  each  in- 
dividual his  proportionate  contribution  toward  the  pay- 
ment of  the  public  obligation,  which  in  some  cases  may 
be  secured  by  a  mortgage,  but  which  usually  rests  upon 
the  honor  of  the  issuing  government  or  municipality. 
The  alternatives  for  a  public  bond-issuing  entity  are, 
usually,  not  payment  and  foreclosure  proceedings,  but 
payment  and  dishonor  with  loss  of  future  borrowing 
power.  Default  is  very  rare.  For  our  present  purpose, 
public  credit  is  made  negotiable  and  acceptable  by  the 
guaranty  of  a  government  or  taxing  district,  while  pri- 
vate credit  is,  generally  speaking,  made  so  by  the  guaranty 
of  a  bank. 

Private  credit,  of  course,  may  come  into  existence, 
serve  its  purpose  and  be  discharged  without  the  inter- 
mediation of  a  bank,  but  this  does  not  ordinarily  happen. 
So  closely  is  the  bank  identified  with  credit  transactions 
that  the  common  test  applied  with  respect  to  the  accepta- 


BANKING  587 

bility  of  credit  is,  "Would  it  be  accepted  by  the  bank?'' 

The  nature  and  origin  of  credit. — Since  banks  are 
primarily  refiners  (not  creators)  of  and  dealers  in  credit, 
we  cannot  have  a  just  conception  of  the  functions  of 
banks  until  we  have  a  clear  idea  of  the  essential  nature 
of  credit.  In  the  chapter  on  "Credit"  will  be  found  a 
discussion  of  credit  especially  with  respect  to  its  formal 
characteristics  and  to  its  employment  in  business  trans- 
actions. Here  we  must  consfder  the  elemental  con- 
stituents of  credit. 

Briefly  defined,  credit  is  present  purchasing  power, 
growing  out  of  potential  or  future  paying  power,  which 
power  itself  grows  out  of  .the  ownership  of  salable 
goods  or  the  ability  to  render  salable  services.  An  "ex- 
tension of  credit"  should  be  thought  of,  accordingly,  pri- 
marily as  an  act  of  borrowing,  not  of  lending.  It  is  the 
exercise  of  the  borrower's  purchasing  power.  Much  con- 
fusion has  been  caused  by  the  fact  that  credit  has  too 
generally  been  regarded  as  something  "granted"  by  the 
lender  instead  of  as  something  exercised  by  the  possessor, 
or  borrower. 

It  may  be  worth  while  to  make  a  further  general  clas- 
sification of  credit  as  being  (i)  primary  or  (2)  second- 
ary ;  that  is,  direct  or  indirect. 

Primary,  or  direct,  credit  grows  out  of  the  immediate 
and  outright  ownership  of  salable  goods  or  the  ability 
to  render  salable  services.  (By  "salable  goods  or 
services"  we  mean  such  as  may  be  sold  for  money  or 
exchanged  for  other  goods  or  services.) 

Secondary,  or  indirect,  credit  grows  out  of  the  future 
paying  power  possessed  by  the  holder  of  a  conditional 


588  PRINCIPLES  OF  BUSINESS 

title  to  salable  goods  or  services^specifically,  by  the 
holding  of  credit  instruments  known  as  "receivables," 
such  as  bonds,  promissory  notes,  and  bills  or  accounts: 
receivable,  representing  credit  which  has  been  negotiated 
or  transferred.  In  this  class  of  credit,  the  risk  element 
has  been  discounted — that  is,  a  margin  of  value  above 
that  of  the  face  of  the  instrument  exists  to  protect  the 
holder  against  unfavorable  contingencies ;  such  credit, 
therefore,  has  a  wider  acceptability  than  what  we  have 
called  primary  credit,  since  it  is  negotiable  and  readily 
convertible  into  money.  The  distinction  between  pri- 
mary and  secondary,  or  direct  and  indirect,  credit,  is  ap- 
parently recognized  in  the  provisions  of  the  Federal  Re- 
serve Act,  under  which  act  the  extending  of  what  we 
have  called  primary  or  direct  credit,  in  the  case  of  a  single 
borrower  from  a  national  bank,  is  limited  to  an  amount 
not  to  exceed  lo  per  cent  of  the  capital  and  surplus  of 
the  lending  bank;  whereas  secondary,  or  indirect,  credit, 
represented  by  the  customer's  "receivables,"'  if  conform- 
ing in  character  to  the  requirements,  may  be  discounted 
by  the  bank  to  an  amount  practically  unlimited. 

The  available  supply  of  credit. — The  limitations  upon 
the  credit  supply,  so  to  speak,  are  fixed  not  by  the  amount 
of  "loanable  funds"  in  existence,  but  by  the  amount  of 
marketable  assets  the  titles  to  which  may  be  hypothecated. 
Wherever  salable  goods  or  services  exist,  the  owner 
thereof  has  a  potential  credit,  corresponding  to  the 
market  value  of  such  goods  or  services,  contingent  upon 
his  willingness  and  ability  to  make  delivery.  By  "serv- 
ices" is  meant,  ability  to  produce  wealth  by  the  exercise 
of  business,  professional  or  manual  skill  or  effort.     Po- 


BANKING  589 

tentially,  then,  the  total  amount  of  credit  that  exists  or 
that  can  be  called  into  existence  is  the  sum  of  the  market 
values  of  all  existing  goods  and  services.  Credit  cannot 
be  created  out  of  anything  but  these  basic  elements.^ 
Effective  credit. — The  amount  of  credit  effective  at 
any  given  time,  however,  is  only  that  portion  of  potential 
credit  which  is  actually  transmuted  into  active  purchas- 
ing power,  expressed  in  terms  of  money,  and  existing 
in  a  negotiable  or  exchangeable  form.  Conceivably,  a 
man  might  own  certain  real  properties,  worth,  say,  $100,- 
000,  owe  nothing  to  anyone,  and  use  gold  in  all  his  buy- 
ing or  selling  transactions.  He  would  in  such  a  case  be 
making  no  use  of  his  potential  credit  of  $100,000.  If 
then,  however,  he  found  that  he  needed  more  money, 
he  might  borrow,  let  us  say,  $1,000,  on  his  mere  promise 
to  pay.  This  $1,000  would  then  be  added  to  the  "credit 
circulation''  of  the  country,  but  there  would  still  be  a 
latent  credit  of  $99,000.  Next,  he  might  desire  to  en- 
gage in  some  business,  for  which  purpose  he  needed 
$50,000  in  "cash."  He  could,  presumably,  borrow  this 
by  giving  a  mortgage  on  his  property.  Leaving  out  of 
consideration  second  mortgages,  or  "speculative"  loans, 
this  would  represent,  practically,  the  limit  of  his  bank- 
able credit,  since  there  is  presumed  always  to  be  a  danger 
that  the  market  value  of  real  estate  will  decline.     The 

1  Confidence  accompanies  credit  so  constantly  that  it  is  often  said 
that  credit  is  based  on  confidence.  This  cannot  be  true,  for  it  is 
credit  that  gives  rise  to  confidence.  For  the  sake  of  illustration, 
the  power  to  pay  for  goods  by  check  is  contingent  on  the  confidence 
the  seller  has  that  the  check  will  be  honored — but  this  confidence 
grows  out  of  the  fact  that  the  purchaser  is  known  to  have  a  bank 
account.  The  character  of  the  borrower,  of  course,  is  vital,  but  is 
merely  a  condition  upon  which  credit  will  be  "granted."  The  credit 
itself  grows  out  of  the  property  of  the  borrower. 


590  PRINCIPLES  OF  BUSINESS 

same  holds  good  with  respect  to  ahnost  any  other  prop- 
erty upon  which  money  may  be  borrowed.  It  is  possible 
to  borrow  close  to  the  market  value,  however,  on  bonds, 
notes,  acceptances,  and  other  transferable  credit  instru- 
ments, because  allowance  has  previously  been  made  for  a 
decline  in  the  market  value  of  the  assets  behind  them. 

Summary. — By  means  of  this  rather  crude  illustration 
it  may  be  seen  that  credit  is  no  more  and  no  less  than 
purchasing  power,  latent  or  active;  that  credit,  potential 
or  active,  may  be  measured  in  terms  of  money  and  tends 
to  approximate  the  value  of  all  marketable  assets,  this 
value  being  expressed,  almost  invariably,  in  terms  of 
money;  that  credit  becomes  active  and  is  put  into  circu- 
lation only  in  so  far  as  it  may  be  desired  to  exercise  the 
available  purchasing  power;  and  that  the  value  of  the 
marketable  assets  upon  the  ownership  of  which  credit 
is  based  is  the  estimated  value  as  of  the  date  when  the 
credit  must  be  liquidated,  or  retired  from  circulation. 
The  greater  the  probability  that  the  assets  will  not  have 
declined  in  value  at  the  time  when  the  credit  is  liquidated, 
the  larger  the  proportion  of  their  present  value  which 
may  be  borrowed. 

While  credit  tends,  as  we  have  observed,  to  approxi- 
mate the  market  value  of  the  assets  behind  it,  as  of  the 
date  of  repayment,  after  50  per  cent  of  the  estimated 
value  has  been  utilized,  in  the  case  of  primary  assets,  it 
is  only  with  increasing  difficulty  and  with  higher  rates 
of  interest,  becoming  prohibitive,  that  the  remainder  of 
the  latent  credit  may  be  made  exchangeable.  In  the 
case  of  assets  representing  what  we  have  called  second- 
ary credit,  however,  such  as  bonds  and  notes  receivable, 


I 


BANKING  591 

an  allowance  has  already  been  made  for  contingencies, 
and  close  to  the  face  value  may  usually  be  borrowed  from 
conservative  lenders,  at  normal  rates. 

Banks  as  refiners  of  credit. — It  is  obvious  that  the 
purchasing  power  latent  in  the  ownership  of  whatever 
has  market  value  can  be  exercised  in  only  two  ways : 
(i)  by  direct  exchange  of  the  goods  (or  barter);  (2) 
by  reduction  of  the  purchasing  power  to  an  exchangeable 
form,  that  is,  to  a  "medium  of  exchange."  It  is  obvious, 
also,  that  if  this  purchasing  power  is  to  be  reduced  to  a 
medium  of  exchange  (money  or  its  equivalent)  the  goods 
must  be  sold,  either  outright  or  conditionally.  Title 
must  pass,  conditionally,  at  least,  even  if  the  goods  them- 
selves are  not  transferred.^ 

The  owner  of  the  goods  may  desire  to  retain  their  use; 
in  such  a  case  he  may  "capitalize"  his  purchasing  power 
by  means  of  a  conditional  transfer  of  title,  expressed  or 
understood,  receiving  in  consideration  of  this  conditional 
transfer  either  the  goods  which  he  desires  to  purchase; 
or  money;  or  a  credit  instrument  of  general  acceptability 
(a  substitute  for  money),  with  which  he  may  make  his 
purchase  on  the  open  market. 

There  are,  of  course,  minor  agencies  through  which 
credit — that  is,  purchasing  power — may  be  capitalized. 
Individuals  may  constitute  themselves  such  agencies; 
note-brokers  and  pawnbrokers  perform  such  a  service; 
negotiations  may  be  carried  on  immediately  with  an 
owner  of  other  goods  which  the  purchaser  wishes  to  ac- 

1  No  attempt  is  made  to  go  into  the  legal  questions  involved  in 
real  estate  mortgages  and  in  chattel  mortgages.  There  was  a  time 
not  very  remote  when  every  mortgage  was  regarded  as  a  conveyance 
of  the  legal  title  to  the  mortgaged  goods. 


592  PRINCIPLES  OF  BUSINESS 

quire.  The  bank,  however,  is  the  agency  of  outstanding 
importance  through  which  latent  purchasing  power  is 
made  active. 

In  order  that  potential  purchasing  power  may  be  trans- 
formed into  a  medium  of  exchange,  several  things  must 
be  done.  ( i )  The  asset  upon  which  the  desired  credit 
is  based  must  be  appraised — that  is,  its  probable  market 
value  estimated — as  of  the  date  when  the  obligation  is 
to  mature.  (2)  A  more  or  less  formal  conditional  trans- 
fer of  title  to  the  asset,  expressed  or  understood,  must 
be  made.  (Such  a  transfer  is  always  implied  In  the 
event  of  default  in  payment,  the  creditor,  through  legal 
proceedings,  may  obtain  and  execute  a  judgment  against 
the  debtor's  property,  even  if  the  property  has  not  been 
specifically  pledged  as  security  for  payment.)  (3)  In 
consideration  of  this  conditional  transfer  the  borrower 
must  receive  either  money,  or  credit  convertible  into 
money  or  its  equivalent,  to  an  amount  not  to  exceed  the 
loan-value  of  the  asset  as  appraised.  If  credit  and  not 
money  is  to  be  the  medium  of  exchange  received  in  con- 
sideration of  the  conditional  transfer  of  title,  the  con- 
vertibility of  the  credit  must  be  assured  by  the  sponsor- 
ship of  a  responsible  guarantor. 

It  is  obvious  that  these  several  processes  in  the  produc- 
tion of  exchangeable  credit  are  proper  functions  of  a 
specialized  institution  such  as  the  bank  has  become.  Pos- 
sessing originally  a  number  of  facilities,  such  as  means 
of  guarding  and  paying  out  funds,  the  bank  has  added 
the  necessary  facilities  for  "credit  granting"  in  its  modern 
form,  maintaining  its  appraisers  of  assets;  its  legal  staff; 
its  means  of  assembling  and  interpreting  "credit  informa- 


BANKING  593 

tion";  its  clientele  among  whom  it  finds  a  market  for 
securities ;  its  accounting  system ;  its  sources  of  money 
funds;  and  its  collecting  system  to  facilitate  the  liquida- 
tion due  and  past-due  accounts. 

Facilities  for  credit-exchange. — The  usefulness  of 
the  bank  does  not  cease,  however,  with  the  completion 
of  the  process  of  transmuting  credit  into  an  exchangeable 
form  and  the  delivery  of  the  "finished  product"  to  the 
borrower.  It  also  provides  facilities  "for  exchange.  It 
has  made  credit  negotiable;  it  now  provides  means  for 
the  transfer  of  negotiable  credit  from  one  holder  to  an- 
other so  that  credit  may  answer  the  same  purpose  as 
money — with  such  economy  in  use  that  credit  has  actually 
displaced  money  as  a  medium  of  exchange  in  practically 
all  except  minor  transactions.  This  has  been  accom- 
plished by  the  development  of  the  deposit  and  checking 
account  system. 

The  nature  of  a  bank  "deposit." — A  depositor  may 
bring  money  or  currency  to  a  bank  and  "deposit"  it,  in 
which  case  he  parts  with  his  goods  by  actual  delivery,  re- 
ceiving in  exchange  the  credit  of  the  bank  to  an  equal 
amount,  measured  in  money.  More  often  he  will  bring 
to  the  bank  his  own  credit,  making  a  conditional  transfer 
of  title  to  certain  assets,  in  consideration  of  which  trans- 
fer of  title  he  receives  the  agreed-upon  amount  of  the 
bank's  credit,  or  of  his  own  credit  guaranteed  by  the 
bank,  which  is  for  practical  purposes  the  same  thing. 
He  has  parted  temporarily  with  the  title  to  his  assets, 
and  has  received  for  them  the  bank's  credit  in  a  usable 
form. 

If  it  is  money  which  he  has  deposited,  he  has  "pur- 


594  PRINCIPLES  OF  BUSINESS 

chased"  a  given  quantity  of  the  bank's  credit.  The  bank 
"redeems"  its  credit  as  he  may  demand,  and  when  the 
last  dollar  is  paid,  that  is,  "withdrawn,"  the  transaction 
is  completed.  The  bank  has  fulfilled  its  obligations  and 
has  rendered  him  the  service  of  cashing  his  checks  as  he 
may  have  requested.  The  money  he  has  withdrawn, 
however,  is  not  the  same  money  which  he  deposited.  It 
has  been  money  paid  on  demand  in  fulfillment  of  the 
bank's  obligation,*  incurred  by  the  acceptance  of  the 
deposit. 

If,  on  the  other  hand,  the  deposit  is  represented  by  a 
promissory  note,  he  has  not  purchased  the  bank's  credit, 
but  borrowed  it,  giving  as  security  his  own  credit,  which 
the  bank,  as  a  refiner  of  credit,  is  able  to  transmute  into 
credit  of  general  acceptability.  The  depositor  may  draw 
checks  upon  the  bank  until  the  deposit  is  exhausted  and 
at  the  maturity  of  the  note  make  repayment,  and  the 
transaction  is  completed. 

The  entire  "deposit,"  obviously,  and  not  only  the  part 
of  the  deposit  which  at  any  time  may  be  represented  by 
checks,  is  to  be  looked  upon  as  a  substitute  for  money — 
the  greater  part  of  which  is  added  to  the  previously  ex- 
isting total  of  the  circulating  medium  of  exchange.  At 
the  time  the  deposit  is  created,  of  course,  a  certain  amount 
of  money  is  withdrawn  from  circulation  to  serve  as  "re- 
serve against  deposits,"  but  this  reserve  is  much  less  than 
the  amount  of  the  deposit. 

How  the  bank  makes  its  profit. — It  may  be  assumed 
that  the  banker  does  not  perform  these  services  merely 
for  the  pleasure  of  handling  money.  The  bank  must 
make  a  profit.    The  interest  the  bank  would  get  in  return 


I 


BANKING  595 

for  lending  its  own  money,  if  it  lent  its  own  money 
(which  it  does  not),  would  not  be  sufficient  to  pay  its 
operating  expenses,  to  say  nothing  of  yielding  a  profit. 
Yet  investments  in  bank  stocks  are  commonly  reputed 
to  be  exceedingly  profitable.  The  explanation  of  the 
profit  of  the  bank  is  in  that  the  money  or  credit  which 
it  lends  to  depositors  is  not  its  own  capital,  but  the  credit 
resources  of  the  depositors  themselves,  converted  into 
money  or  its  equivalent  by  the  acceptance  and  guaranty 
of  such  resources  by  the  bank.  Practically,  then,  the  bank 
lends  depositors  their  own  money  at  a  rate  of  interest, 
and  lends  at  least  five  times  as  much  as  it  keeps  in  its 
vaults  or  in  the  vaults  of  other  banks  in  the  form  of 
"cash"  for  reserves  against  demands.  This  practice, 
however,  is  quite  safe  and  quite  legitimate. 

Lending  deposits  is  a  process  in  some  respects  so  sim- 
ilar to  the  issue  of  notes,  that  a  brief  description  of  note 
issue  may  help  to  explain  the  deposit  issue.  Note  issue 
was  formerly  a  usual  prerogrative  of  banks,  but  is  now 
practically  confined,  in  the  United  States,  to  the  Federal 
Reserve  banks.  In  its  simplest  form,  note  issue  may  be 
described  as  follows:  In  the  seventeenth  century  (about 
the  year  1650),  when  bankers  began  to  emerge  from 
the  guild  of  goldsmiths  and  began  the  business  of  col- 
lecting money  in  strong-boxes  and  lending  it  at  interest, 
they  discovered  that  their  "depositors"  drew  out,  on  the 
average,  from  month  to  month,  only  a  small  proportion 
of  the  funds  left  for  safekeeping.  The  "banker."  there- 
fore, found  that  he  could  safely  lend  most  of  the  money 
entrusted  to  him,  keeping  merely  enough  cash  in  reserve 
to  satisfy  such  demands  as  might  be  made.     From  this 


596  PRINCIPLES  OF  BUSINESS 

situation  was  evolved  the  perfectly  satisfactory  custom 
of  lending,  instead  of  actual  coin,  notes  redeemable  in 
coin,  the  notes  being  transferable  from  hand  to  hand 
and  redeemable  upon  presentation.  It  can  easily  be  seen 
how  this  constituted  a  source  of  profit  to  the  bank,  for  it 
could  lend  at  interest,  upon  satisfactory  security,  an 
amount  greatly  in  excess  of  the  money  held  as  reserves. 
The  bank  itself  paid  no  interest  upon  its  own  notes, 
except  perhaps  in  the  form  of  an  inconsiderable  tax  as- 
sessed by  the  government.  In  the  United  States,  how- 
ever, in  order  to  encourage  national  banks  at  the  expense 
of  others,  a  tax  of  lo  per  cent  was  imposed  on  notes 
issued  'by  State  or  private  banks. 

It  will  be  remembered  that  the  raw  material  of  credit 
is  purchasing  power  based  upon  the  ownership,  legal  or 
actual,  of  assets  which  have  a  market  value — which,  in 
other  words,  are  ultimately,  even  if  not  immediately  or 
conveniently,  convertible  into  money.  The  bank  takes 
this  crude  credit,  with  legal  title  to  the  assets,  and  trans- 
forms it  into  its  own  credit  (which  is  readily  convertible 
into  money)  and  lends  this  credit  to  the  borrower,  hold- 
ing the  legal  title  to  the  pledged  assets  as  security  that 
the  refined  credit  shall  be  returned  to  the  bank  at  the 
specified  time,  to  be  reconverted  into  the  original  crude 
credit  and  given  back  to  the  borrower.  This  is  accom- 
plished simply  by  returning  to  the  borrower  the  hypothe- 
cated title  to  the  assets  upon  which  both  forms  of  the 
credit  were  based.  Thus  the  borrower,  not-  the  bank,  sup- 
plies the  material  out  of  which  is  made  the  money  or 
credit  which  he  borrows.  The  interest  which  the  bank 
receives  for  the  use  of  the  "refined  credit"  extended  is 


BANKING  597 

very  much  more  than  the  cost  of  the  transaction — which 
consists  simply  in  "passing"  upon  the  appHcant's  credit, 
accepting  it,  and  issumg  its  own  credit  temporarily  in 
exchange  for  the  applicant's  credit/ 

It  must  be  remembered,  also,  that  while  the  credit 
which  the  bank  lends  the  borrower  is  convertible  into 
money  (gold  or  legal  tender)  or  current  substitutes  for 
money  (Federal  Reserve  notes  or  bank  notes)  upon  the 
borrower's  demand,  the  average  borrower  rarely  makes 
such  a  demand  except  with  respect  to  a  very  small  pro- 
portion of  the  credit  he  receives  from  the  bank.  Most 
of  his  payments  are  made  by  check,  and  the  checks  drawn 
tend  to  offset  other  checks  deposited,  so  that  settlements 
are  made,  as  a  rule,  merely  by  an  act  of  bookkeeping. 
Behind  each  dollar  of  credit,  however,  there  is  an  asset 
of  sufilicient  market  value,  ultimately  convertible  into 
money,  to  insure  the  protection  of  the  dollar  of  credit. 
Besides,  there  is  the  legal  gold-reserve. 

Certainly,  if  it  were  demanded  that  all  the  assets  be- 
hind the  credit  of  the  banks  of  the  country  should  be 
converted  into  money  at  the  same  time,  this  could  not  be 
done;  for  there  is  not  sufficient  money  in  the  world  to 
accomplish  such  an  undertaking.  It  is  safe  to  assume 
that  such  a  demand,  or  any  demand  approximating  it, 
will  never  be  made,  and  that  the  demands  for  the  conver- 
sion of  nominally  convertible  credit  into  actual  money 

1  We  may  say  for  convenience  that  the  bank  exchanges  its-  own 
credit  for  the  applicant's  credit,  but  it  must  be  remembered  that 
what  we  refer  to  as  the  bank's  own  credit  is  really  based  largely 
upon  the  applicant's  pledged  assets,  which  augment  for  the  period 
of  the  loan  the  total  resources  or  credit  of  the  bank.  The  bank's 
credit  is  based  on  the  borrower's  assets,  plus  the  assets  directly 
owned  by  the  bank  itself. 


598  PRINCIPLES  OF  BUSINESS 

will  remain  within  the  limits  which  experience  has  in- 
dicated are  to  be  expected.  It  would  be  as  unreasonable 
to  question  the  soundness  of  the  credit  system  because  of 
the  practical  impossibility  of  redemption  of  all  converti- 
ble credit  in  money  as  it  would  be  to  doubt  the  correct- 
ness of  the  valuations  set  upon  marketable  goods  and 
property  because  of  the  fact  that  if  all  goods  were  re- 
quired to  be  sold  at  the  same  time,  there  would  not  be 
enough  money  in  the  world  with  which  to  make  even  a 
reasonable  partial  payment  at  the  given  valuation. 

The  statement  is  often  made,  presumably  as  a  well- 
meant  warning,  that  what  is  borrowed  in  credit  must 
eventually  be  repaid  in  money.  The  statement  is  correct, 
if  we  leave  off  the  last  two  words.  A  lender  requires 
the  return  of  what  he  lends — not  of  something  else.  It 
is  well  known  that  credit  offsets  credit,  and  that  nearly 
all  of  the  world's  business  is  transacted  with  credit  as 
the  sole  medium  of  exchange. 

The  distribution  of  credit. — The  banks  then  lend 
their  credit  or  decline  to  lend  it,  thereby  making  or  un- 
making businesses,  stimulating  or  discouraging  produc- 
tion, or  diverting  it  from  one  channel  to  another.  They 
assume  a  heavy  responsibility,  but  one  which  is  unavoid- 
able. They  do  not  create  credit,  but  have  what  is  prac- 
tically a  monopoly  of  the  process  of  making  credit  usable, 
which  is  almost  the  same  as  creating  it,  so  far  as  their 
control  of  credit  is  concerned.  Credit,  of  course,  is  con- 
trolled ultimately  by  supply  and  demand,  but  supply  and 
demand  are  largely  under  the  control  of  the  banks.  It  is 
the  duty  of  the  banks  to  survey  the  fields  of  commerce 
and  industry  and  to  ascertain  what  the  needs  of  business 


BANKING  599 

are,  and  what  they  will  be.  The  farther  into  the  future 
the  banks  are  able  to  project  their  sensitiveness  to  the 
needs  of  business,  the  better  they  are  able  to  make  pro- 
vision for  those  needs  and  to  prevent  the  economic  waste 
that  arises  from  various  maladjustments. 

Banks,  like  people,  are  actuated  by  selfish  motives, 
but  selfishness  and  humanitarianism,  projected  far 
enough  into  the  future,  tend  to  coincide.  The  banks  de- 
sire first  of  all  to  make  the  largest  profit  which  can  legit- 
imately be  made,  but  their  far-seeing  policy  might  be 
expressed  in  the  paraphrase :  Seek  first  the  stability  of 
business,  and  profit  shall  be  added  unto  you.  The  banks* 
stock-in-trade  is  credit;  and  credit,  as  we  have  seen, 
grows  out  of  wealth,  and  wealth  is  increased  by  the 
processes  of  industry  and  commerce.  Accordingly,  while 
it  might  seem  that  the  sole  consideration  which  deter- 
mines the  granting  or  refusing  of  credit  by  the  bank, 
assuming  that  it  has  loanable  funds,  is  the  willingness 
and  ability  of  the  applicant  to  liquidate  the  loan  at  ma- 
turity, the  purpose  for  which  the  proceeds  of  the  loan 
will  be  used  is  also  a  factor  in  the  decision.  The  bank 
uses  its  judgment  not  only  with  respect  to  the  safety  of 
its  credit,  but  also  with  respect  to  the  probable  financial 
success  of  the  proposed  undertaking  which  the  applicant 
has  in  mind;  and  in  a  lesser  degree,  with  respect  to  the 
economic  value  of  the  undertaking,  granting  that  it  is 
likely  to  be  profitable  financially.  The  tendency,  at  any 
rate,  is  for  consideration  to  be  given  to  the  economic 
aspects  of  a  proposed  undertaking,  even  if  for  no  reason 
other  than  that  a  business  which  is  upon  a  substantial 
economic  foundation  is  more  likely  to  be  permanently 


6oo  PRINCIPLES  OF  BUSINESS 

successful  than  one  which  is  not,  and  is  therefore  a 
better  "risk,"  both  with  respect  to  the  immediate  loan 
and  with  respect  to  possible  subsequent  loans. 

An  interesting  illustration  of  how  the  banks  of  the 
country  may  control  the  direction  of  the  activities  of 
business  by  the  extension  or  non-extension  of  credit  is 
seen  in  the  following  resolution,  adopted  by  the  board  of 
directors  of  the  Federal  Reserve  Bank  of  New  York, 
July  31,  1 918,  while  the  European  War  was  in  progress: 

"Resolved,  That  the  directors  of  the  Federal  Reserve  Bank  of 
New  York,  in  full  sympathy  with  the  views  of  the  board  (Federal 
Reserve  Board),  hereby  direct  the  officers  of  the  bank,  in  such 
ways  as  may  be  appropriate,  to  express  to  the  banking  institutions 
of  this  district  the  importance  and  necessity  of  conserving  credit. 

"By  endeavoring  to  secure  such  gradual  reduction  as  may  be 
practicable  of  loans  now  carried  for  non-productive  or  non-distribu- 
tive purposes ; 

"By  gradually  reducing  the  amount  of  credit  granted  for  purposes 
not  clearly  necessary  for  the  prosecution  of  the  war  or  the  health 
and  necessary  comfort  of  the  people,  and 

"By  educating  borrowers  of  all  classes  to  keep  their  demands  for 
credit  down  to  the  very  minimum. 

"Such  a  concerted  campaign  of  action  and  education  by  the  bank- 
ing institutions  of  this  district  will  surely  lead  to  a  spirit  of  econ- 
omy in  credit  transactions,  as  well  as  to  an  actual  saving  of  credit 
comparable  to  the  saving  already  effected  in  food  and  other  com- 
modities, and  will  enable  the  Government  to  command  the  credit 
thus  saved  and  use  it  directly  and  with  full  force  for  the  winning 
of  the  war. 

"It  is  of  the  highest  importance,  however,  that  nothing  should 
be  done  to  cause  undue  embarrassment  to  borrowers  or  affect  neces- 
sary credits." 

The  purpose  of  this  resolution  was  primarily  to  deflect 
credit  from  all  uses  which  were  not  directly  concerned 
with  the  prosecution  of  the  war.  It  may  be  expected, 
from  this  beginning,  however,  that  for  the  future,  even 
in  times  of  peace,  the  banks  will  endeavor,  at  least  to 
some  extent,  to  control  the  distribution  of  credit  with 
economic  ends  in  view. 


BANKING  6oi 

Since  banks  can  make  or  unmake  businesses  simply 
by  extending  or  withholding  credit,  it  is  no  more  than 
was  to  be  expected  that  their  attitude  toward  business 
should  have  become  somewhat  paternalistic.  That  they 
have  assumed  a  paternalistic  habit  of  mind  is  not  to  be 
denied,  although  the  fact  is  somewhat  obscured  by  reason 
of  its  familiarity,  and  partly  by  reason  of  the  necessity 
a  bank  is  under  of  protecting  its  own  credit  as  well  as 
that  of  its  depositors.  This  necessity  compels  a  very 
careful  scrutiny  of  each  business  which  asks  for  credit. 
In  the  main,  however,  it  must  be  granted  that,  whether 
paternalistic  or  not,  the  interest  which  the  bank  takes 
in  the  business  transactions  of  its  clients  is  helpful  to  the 
individual  and  to  business  as  a  whole. 

A  function  of  banks,  therefore,  is  seen  to  be,  by  de- 
flection of  credit  into  the  most  economically  productive 
channels,  to  bring  about  such  a  distribution  of  credit  a§ 
will  add  most  to  the  productive  power  of  business  as  a 
whole;  for  exchangeable  credit,  or  effective  purchasing 
power,'  enables  the  holder  to  obtain  possession  or  con- 
trol of  the  machinery  of  production. 

Credit  and  prices. — The  question  inevitably  arises,  if 
credit  takes  the  place  of  money  as  a  medium  of  exchange, 
almost  to  the  exclusion  of  money,  what  effect  does  this 
have  upon  prices?  Manifestly,  this  problem  is  such  a 
complicated  one  that  a  discussion  here  would  be  profit- 
less, since  the  problem  is  too  difficult  even  to  be  presented 
in  a  few  pages,  much  less  discussed.  Economists  have 
not  been  able  to  agree  among  themselves  as  to  what  the 
extent  of  the  influence  is  of  credit  currency  upon  prices. 
The  best  opinion  seems  to  be  that  credit  when  accepted 


6o2  PRINCIPLES  OF  BUSINESS 

as  money  tends  to  have  the  same  effect  as  an  increase 
of  money,  but  that  when  credit  currency  comes  into  ex- 
istence, new  business-needs  for  money  arise,  so  that 
there  is  not  necessarily  an  actual  increase  of  money  in 
relation  to  the  demand  for  money.  Since,  however, 
credit  currency  circulates  more  than  twice  as  rapidly  as 
money  does,  the  supply  of  money  is  to  that  extent  effect- 
ively increased.  Here,  again,  of  course,  the  increased 
velocity  of  circulation  gives  rise  to  the  possibility  of  new 
business-undertakings  and  a  consequent  increase  in  the 
demand  for  money. 

Corrective  measures,  however,  in  case  of  an  apparent 
superabundance  or  scarcity  of  the  medium  of  exchange, 
are  practically  futile,  as  explained  by  Taussig,^  for  the 
reason  that  prices  respond  so  slowly  to  changes  in  the 
quantity  of  money  that  prediction  is  not  easy. 

"The  best  check,''  says  Professor  Taussig,  "to  the 
regular  fluctuations  in  tlie  uses  of  credit  devices  is  that 
they  shall  rest  securely  on  specie,  and  that  all  forms  of 
them  shall  be  redeemable  without  fail  in  specie.  So  long 
as  this  is  done,  there  will  be  neither  ven-  wide  fluctua- 
tions in  the  course  of  any  one  generation,  nor  very 
abrupt  fluctuatons  at  any  time." 

The  opinion  quoted  above  was  given  before  the  out- 
break of  the  war,  and  before  the  establishment  of  the 
Federal  Reserve  System.  The  credit  currency  arising 
from  rediscounts  under  the  Reserve  System  is,  of  course, 
redeemable  in  gold,  and  it  would  seem  that  the  country's 
monetary  system  is  on  as  secure  a  foundation  as  could 
have  been  laid.    The  correctness  of  this  statement  has  been 

^Principles  of  Economics,  p.  443. 


BANKING  60s 

demonstrated  since  the  close  of  the  European  War.  The 
wide  and  abrupt  tiuctuations  in  foreign  currencies  that  oc- 
curred in  1920  and  1921  were  largely  traceable  to  the  dis- 
appearance of  a  specie  basis  from  the  monetary  systems  of 
European  countries.  While  America  remained  on  a  gold 
basis,  even  here  the  difficulty  in  obtaining  gold  contributed 
somewhat  to  the  derangement  of  our  economic  system. 

CLASSES  OF  BANKS 

Classification  of  business  needs. — Naturally,  in  this 
age  of  specialization,  banks  with  special  facilities  have- 
been  evolved  in  order  to  meet  the  needs  of  business  for 
several  more  or  less  distinct  kinds  of  banking  service. 
The  needs  of  business  with  respect  to  credit  are,  pri- 
marily, for  long-term  credit  and  short-term  credit.  The 
former  is  generally  associated  with  industry,  the  latter 
with  commerce.  The  distinction  between  industry  and 
commerce,  however,  is  merely  incidental  and  not  funda- 
mental. The  practical  distinction  is  in  the  length  of  the 
term  of  the  loan. 

Long-term  loans,  generally,  are  needed  for  the  pur- 
chase of  permanent  capital  and  for  the  securing  of  funds 
to  serve  as  normal  or  regular  "working  capital"  as  dis- 
tinguished from  funds  to  satisfy  some  seasonal  demand. 

Short-term  loans  are  needed  for  equalizing  the  variable 
demands  for  '"working  capital,"  month  by  month.  A 
manufacturing  or  industrial  enterprise  may  have  as  legit- 
imate a  need  for  short-term  loans,  from  the  standpoint 
of  banking,  as  may  the  merchant,  whose  needs  are  in 
greater  proportion,  however,  for  short-time  loans. 

The  commercial  and  other  "business  banks"  them- 
selves, which  distribute  credit  according  to  the  current 


6o4  PRINCIPLES  OF  BUSINESS 

needs  of  business,  whether  these  needs  are  for  long-term 
credit  or  short-term  credit,  are  dependent  for  banking 
credit  upon  banks  in  the  financial  centers,  and,  particu- 
larly, upon  the  recently  established  "Federal  Reserve" 
banks.  Banks  of  this  latter  class — which  supply  ex- 
changeable credit  to  business  banks — are  called  "bankers' 
banks."' 

Classification  of  banks. — Corresponding  to  the  three 
needs  of  business,  noted  above,  for  long-term  credit, 
short-term  credit  and  bankers'  credit — we  have  three 
classes  of  banks — investment  or  "industrial"'  banks,  com- 
mercial banks,  and  "bankers'  banks." 

It  may  be  noted  here,  that  while  the  task  of  supplying 
short-term  business  credit  devolves  almost  exclusively 
upon  the  so-called  commercial  banks,  these  commercial 
banks  do  not  restrict  themselves  by  any  means  to  the 
making  of  short-term  loans.  While  it  is  rarely  that  long- 
term  loans  are  made  to  depositors,  such  banks  do  invest 
a  large  part  of  their  resources  in  the  purchase  of  long- 
term  securities,  which  is  practically  equivalent  to  making 
long-terra  loans,  or  to  lending  for  investment  purposes, 
with  this  distinction,  however — that  such  securities,  while 
not  redeemable  by  the  issuing  corporations,  are  really 
quick  assets,  convertible  into  cash  in  the  ready  market 
of  the  stock  exchange.  There  is,  apparently,  no  objec- 
tion to  the  custom  referred  to,  if  it  does  not  interfere  with 
what  has  come  to  be  looked  upon  as  the  proper  function 
of  the  commercial  bank — the  supplying  of  short-term 
credit  in  such  quantities  as  may  be  required. 

With  respect  to  the  most  conspicuous  services  they  ren- 


BANKING 


605 


ORGANIZATION    OF    A    BANK 

(Guaranty  Trust  Company  of  New  York) 


6o6  PRINCIPLES  OF  BUSINESS 

der,  banks,  then,  may  be  grouped  as  follows,  the  descrip- 
tive group-titles  being,  however,  only  approximately 
justifiable,  but  as  little  misleading,  perhaps,  as  any  that 
could  be  found : 

1.  Industrial  banks.^ 

(a)  Investment  banks 

(b)  Trust  companies 

(c)  Savings  banks 

(d)  Rural-credit  banks 

2.  Commercial  banks. 

(a)  Private  commercial  banks 

(b)  State  banks 

(c)  National  banks 

3.  Bankers'  banks 

(a)  Metropolitan  commercial  banks. 

(b)  Federal  Reserve  banks 

Industrial  or  investment  banks. — The  essential  char- 
acteristic of  banks  of  the  class  which  we  may  call  indus- 
trial banks,  since  their  lending  is  principally  for  the 
promotion  of  industry  rather  than  of  commerce,  is  that 
such  banks  ordinarily  lend  for  long  terms  rather  than  for 
short  terms.  Briefly  to  distinguish  between  the  several 
classes  of  such  banks,  the  investment  bank  is  actively  en- 
gaged in  the  promotion  of  industrial  and  other  enter- 
prises; the  trust  company  is  a  lender,  as  distinguished 
from  a  promoter;  the  savings  bank  is  an  investor  as  dis- 
tinguished from  both  the  foregoing,  in  the  sense  that  all 
elements  of  speculation  are  eliminated  so  far  as  possible, 

^  The  term  "industrial  bank"  is  frequently  used  as-  a  title  by 
commercial  banks  which  make  a  specialty  of  handling  the  small 
accounts  of  working  people.  In  the  sense  in  which  the  term  is  used 
in  our  classification,  however,  it  refers  to  "industry"  as  distin- 
guished from  "commerce," 


BANKING  607 

safety  being  the  first  concern ;  while  the  rural-credit  bank 
is  especially  designed  to  promote  industry  of  an  agricul- 
tural nature. 

Investment  banks. — "Investment  bank"  is  a  specific 
term  used  to  designate  the  private  bank  which  deals  pri- 
marily in  long-term  securities  connected  with  the  promo- 
tion of  enterprises.  Not  infrequently  the  banking  house 
itself  will  initiate  the  organization  of  a  new  business  or 
the  reorganization  of  an  old,  and  supervise  the  marketing 
of  its  securities,  underwriting  them  and  marketing  them 
among  the  buyers  who  compose  its  clientele.  Emphasis 
is  laid  upon  the  fact  that  the  investment  bank  is  not  a 
merely  passive  investor;  it  seeks  not  only  interest  on  its 
investments  but  a  profit  or  a  commission  upon  the  resale 
of  the  securities  it  handles.  The  house  of  J.  P.  Morgan 
and  Company  is  an  example  of  this  type  of  bank.  Almost 
any  legitimate  big-scale  proposition  will  interest  such  a 
house  as  this. 

The  funds  which  constitute  the  working  capital  of  such 
a  banking  firm  are  usually  investment  funds  already  in 
existence,  as  distinguished  from  the  deposit  funds  created 
by  commercial  banks  out  of  the  crude  resources  of  the 
borrower.  Such  a  bank  has  practically  unlimited  funds 
at  its  command,  owned  in  part  by  the  partners  of  the 
firm  and  in  part  by  the  clients  of  the  bank,  who  are  ready 
to  lend  their  money  or  credit  upon  the  simple  recommen- 
dation of  the  house.  The  borrowing  power,  and  conse- 
quently the  lending  power  of  such  a  combination,  together 
with  its  banking  connections,  is  practically  without  limit. 
Any  feasible  undertaking  whatever  can  be  handled;  the 
larger  it  is  the  better  they  like  it.     The  formation  of  the 


6o8  PRINCIPLES  OF  BUSINESS 

United  States  Steel  Corporation,  for  example,  is  one  of 
the  Morgan  exploits. 

It  is  unfortunate,  perhaps,  that  there  are  no  such  invest- 
ment banking  services  available  for  lesser  businesses.  In 
the  nature  of  things,  however,  men  of  the  calibre  of  the 
big  investment  bankers  cannot  devote  their  attention  to 
small  enterprises,  and  it  is  the  attention  given  by  compe- 
tent financiers  that  makes  for  success — the  exercise  of 
competent  judgment.  The  credit  facilities  without  the 
personal  attention  of  competent  men  would  be  of  minor 
value,  even  if  they  did  not  lead  to  misdirection  of  effort 
and  misemployment  of  capital.^ 

Trust  companies. — The  trust  company  type  of  bank 
approaches  rather  closely  to  that  of  the  true  bank.  It 
deals  largely  in  what  we  have  called  "primary  credit"  (see 
p.  587),  creating  new  loans  and  issuing  deposits.  In 
some  cases,  however,  these  are  time  deposits,  without  the 
"checking  account"  privilege.  Such  deposits  are  usually 
based  on  previously  accumulated  funds,  deposited  for 
safekeeping  at  a  very  conservative  rate  of  interest.  Such 
new  loans  as  are  created  are  likely  to  be  withdrawn  from 
deposit  immediately  for  permanent  investment  in  the 
borrower's  business  or  for  whatever  other  purpose  he 
may  have  for  the  funds,  since  the  borrower  must  pay  a 
higher  rate  of  interest  on  his  loan  than  the  bank  will  pay 
on  a  time  deposit.  The  time  deposit  can  be  "loaned," 
with  a  very  small  proportion  retained  as  a  reserve  against 
demand. 

Trust  companies  supply  a  large  part  of  the  long-term 

1  Investment  banks  generally  conduct  a  regular  banking  business 
besides  dealing  in  securities.  Some  of  them  have  deposits  subject 
to  check  that  run  into  the  million3. 


BANKING  609 

credit  employed  in  business  for  the  purchase  of  fixed 
assets  and  as  permanent  working  capital.  They  also 
supply  much  of  the  special  working  capital,  as  in  the 
financing  of  operations  which  require  extra  capital  for  a 
longer  period  than  that  of  the  usual  commercial  short- 
term  loan.  The  trust  company  is  also  a  source  of  finan- 
cial assistance  in  agricultural  operations,  lending  money 
on  farm  lands  for  the  purpose,  preferably,  of  improve- 
ments. 

Many  trust  companies  have  added  commercial  banking 
departments  to  their  other  facilities.  In  the  East,  the 
banking  department  of  a  trust  company  is  often  its  most 
conspicuous  feature,  a  trust  company  being  regarded  as 
a  State  bank  with  trust  company  powers  or  privileges. 
The  term  "State  bank  and  trust  company"  is  frequently 
used  as  a  title  by  a  State  bank  with  trust  company  priv- 
ileges, while,  especially  in  the  West,  the  "trust  company" 
or  "loan  and  trust  company"  may  confine  its  activities  to 
accepting  time  deposits,  making  loans  on  real  estate,  and 
lending  on  or  dealing  in  long-term  securities. 

The  original  function  of  the  trust  company,  which 
tends  to  become  subordinated,  is  the  management  of 
estates  or  funds  in  a  fiduciary  capacity.  Following  this 
first  activity,  the  trust  companies  branched  out  into  en- 
gaging in  business  for  themselves  as  well  as  for  the  bene- 
fit of  those  for  whom  they  acted  as  trustees,  administra- 
tors, guardians  and  executors.  Making  loans,  financing 
new  enterprises  and  dealing  in  securities  generally  become 
part  of  their  regular  business.  One  of  the  most  recent 
developments  is  the  commercial  banking  department, 
noted  above.     As  well  as  the  tendency  for  the  trust  com- 


6io  PRINCIPLES  OF  BUSINESS 

pany  to  assume  banking  functions,  we  may  note  the  tend- 
ency of  State  banks  to  add  trust  company  functions  to 
their  commercial  banking  functions.  A  very  important 
function — not  a  banking  function,  however — is  the  super- 
vising of  organizations  and  reorganizations,  furnishing 
competent  services  in  assuring  the  formal  correctness  of 
issues  of  securities,  and  perhaps  themselves  underwriting 
the  issues/ 

Savings  banks. — From  the  standpoint  of  the  deposi- 
tor, savings  banks  are  what  their  name  implies — banks 
in  which  savings  are  accumulated.  In  some  cases,  the 
depositors  may  have  a  checking  privilege.  This  feature 
is  found  only  in  stock  savings  banks,  however,  and  there 
only  rarely.  Ordinarily,  however,  money  may  not  be 
withdrawn  except  at  the  end  of  interest  periods  under 
penalty  of  forfeiture  of  all  or  a  part  of  the  accrued  inter- 
est. From  the  standpoint  of  business,  however,  the  sav- 
ings bank  is  of  interest  chiefly  as  a  source  of  investment 
funds,  accepting  only  the  most  conservative  securities. 
Legal  provisions  of  the  various  States  define  the  classes 
of  securities  in  which  savings  funds  may  be  invested. 
The  importance  of  savings  banks  as  sources  of  invest- 
ment funds  may  be  seen  in  the  immensity  of  their  de- 
posits, which  run  into  the  billions. 

Savings  banks  in  the  United  States,  exclusive  of  the 
Postal  Savings  Bank,  are  of  two  important  classes,  mu- 
tual and  stock.     Mutual  savings  banks  are  not  organized 

1  As  registrars  of  stock  they  prevent  the  issue  of  spurious  stock 
by  careless  or  defauhing  corporate  officers;  as  transfer  agents  they 
do  the  clerical  work  connected  with  the  transfer  of  ownership  of 
stocks  and  bonds ;  as  depositaries,  they  accept  stock  and  bonds 
under  reorganization  and  other  agreements. 


BANKING  6ii 

for  profit  as  banks,  but  for  the  benefit  of  their  depositors, 
being  managed  by  trustees  who  receive  salaries,  the 
profits  being  returned  to  the  depositors  in  the  form  of 
interest  on  their  deposits. 

Stock  savings  banks,  however,  are  managed  for  profit ; 
interest  is  paid  on  deposits,  and  profits  are  paid  as  divi- 
dends to  the  stockholders.  The  stock  savings  bank, 
naturally,  is  more  aggressive  than  is  the  mutual  savings 
bank,  and  is  fundamentally  sounder,  having  the  liability 
of  the  stockholders  as  a  partial  guaranty  against  loss. 
The  mutual  savings  bank,  on  the  other  hand,  must  de- 
pend altogether  upon  the  intelligence  and  good  faith  of 
its  trustees  and  upon  the  protection  afforded  by  legislation 
restricting  investments  to  the  most  approved  types  of 
securities. 

Rural-credit  banks. — Under  the  Federal  Farm  Loan 
Act  of  July  17,  19 16,  provision  is  made  for  the  extending 
of  long-term  credit  for  agricultural  purposes.  Two  sys- 
tems of  banks  were  established  or  authorized — Federal 
land  banks  and  joint-stock  land  banks. 

The  Federal  land  banks  established  under  the  act  re- 
ferred to  are  twelve  in  number,  one  in  each  of  the  twelve 
districts  into  which  the  country  for  this  purpose  is 
divided.  Each  bank  may  have  branches  within  the  dis- 
trict. The  capital  stock  of  each  bank  is  not  less  than 
$750,000,  subscribed  at  first  by  the  public  in  general,  with 
provision  for  subscriptions  by  the  Government  to  such 
a  portion  of  the  stock  as  might  not  have  been  subscribed 
by  the  public  within  thirty  days  after  the  stock  was  offered 
for  sale.  The  ultimate  ownership  of  the  stock  of  the  land 
banks,  however,  is  intended  to  be  in  "national  farm  loan 


6i2  PRINCIPLES  OF  BUSINESS 

associations,"  organized  by  persons  desiring  to  borrow 
money  on  farm  mortgage  security  under  the  terms  of  the 
Act.  Such  a  borrowers'  association  must  consist  of  "ten 
or  more  natural  persons  who  are  the  owners,  or  about 
to  become  the  owners,  of  farm  land  qualified  as  security 
for  a  mortgage  loan  under  section  twelve  of  this  Act." 
The  aggregate  amount  to  be  borrowed  must  be  not  less 
than  $20,000,  which,  on  compliance  by  the  association 
with  the  terms  of  the  Act,  it  may  receive  from  the  Federal 
land  bank  and  apportion  among  its  individual  members. 
The  maximum  loan  which  may  be  made  to  any  one  mem- 
ber is  $10,000.  The  association  must  subscribe  to  an 
amount  of  stock  equal  to  five  per  cent  of  the  amount  bor- 
rowed, to  be  held  by  the  bank  as  security  and  to  be  re- 
tired upon  repayment  of  the  loan.  Stock  so  issued  to 
these  associations  is  designed  to  supersede  the  stock 
originally  subscribed  by  the  general  public  and  the 
Government. 

Loans  are  made  at  a  rate  of  interest  not  to  exceed  six 
per  cent,  and  for  a  period  of  not  less  than  five  nor  more 
than  forty  years,  the  loan  being  amortized  by  serial  pay- 
ments. 

The  provisions  as  to  purposes  for  which  money  may  be 
borrowed  under  the  Federal  Farm  Loan  Act  are : 

(a)  To  provide  for  the  purchase  of  land  for  agricul- 
tural uses. 

(b)  To  provide  for  the  purchase  of  equipment,  fer- 
tilizers and  live  stock  necessary  for  the  proper  and  rea- 
sonable operation  of  the  mortgaged  farm.  The  term 
"equipment"  is  to  be  defined  by  the  Federal  Farm  Loan 
Board. 


BANKING  613 

(c)  To  liquidate  indebtedness  of  the  owner  of  the  land 
mortgaged,  existing  at  the  time  of  the  organization  of 
the  first  national  farm  loan  association  established  in  or 
for  the  county  in  which  the  land  mortgaged  is  situated, 
or  indebtedness  subsequently  incurred  for  purposes  men- 
tioned in  this  section. 

No  such  loan  may  exceed  fifty  per  cent  of  the  value  of 
the  land  mortgaged  and  twenty  per  cent  of  the  value  of 
the  permanent  insured  improvements  upon  the  land,  the 
value  to  be  ascertained  by  appraisal,  as  provided  in  the 
Act. 

In  addition  to  the  Federal  land  banks,  the  Federal 
Farm  Loan  Act  gives  authority  for  the  organization  of 
joint-stock  land  banks,  under  the  supervision  of  the 
Board,  but  independent  of  Government  financial  assist- 
ance and  somewhat  less  restricted  as  to  their  operations. 

A  joint-stock  land  bank,  properly  incorporated,  may 
be  formed  by  any  number  of  natural  persons  not  less  than 
ten.  The  capital  stock  required  to  be  subscribed  is  a 
minimum  of  $250,000,  one-half  paid  in  and  the  balance 
subject  to  call  by  the  board  of  directors.  No  such 
bank  may  issue  or  obligate  itself  for  outstanding  farm 
loan  bonds  in  excess  of  fifteen  times  the  amount  of  its 
capital  and  surplus,  and  may  not  receive  deposits  or 
transact  any  banking  business  not  expressly  authorized 
by  the  Act,  nor  may  it  issue  any  bonds  until  its  capital 
stock  is  fully  paid  in. 

COMMERCIAL  BANKS 

The  purpose  of  commercial  banks. — Commercial 
banks,  as  distinguished  from  what  we  have  called  "in- 


6i4  PRINCIPLES  OF  BUSINESS 

dustrial"  banks,  have  as  their  most  conspicuous  activity 
the  supplying  of  short-term  credit.  Their  faciHties  for 
the  transfer  of  convertible  credit  from  one  holder  to  an- 
other— in  other  words,  the  facilities  afforded  by  their  sys- 
tem of  deposits  and  checking  accounts — are  open  to  all 
alike — manufacturers,  merchants,  or  professional  men, 
regardless  of  the  purposes  for  which  the  funds  are  to  be 
used.  In  general,  anyone  with  money  may  deposit  it  in 
a  commercial  bank  and  check  against  it  as  he  pleases, 
although  the  larger  banks  will  not  accept  accounts  which 
do  not  involve  the  keeping  of  a  fairly  large  average 
amount  on  deposit  and  while,  moreover,  all  banks  prefer 
to  accept  deposits  only  from  reputable  persons.  So  far 
as  deposits  and  checking  privileges,  as  such,  are  con- 
cerned, however,  no  discrimination  is  made  with  respect 
to  the  purpose  for  which  the  funds  are  used. 

Again,  with  respect  to  loans  made  by  commercial 
banks,  the  first  consideration  is  that  they  shall  be  based 
on  liquid  assets — assets  that  are  readily  convertible  into 
"cash"  at  any  time,  or  that  in  all  probability  will  be  con- 
verted into  cash  within  thirty,  sixty  or  ninety  days. 

It  cannot  be  said  that  the  bank  is  interested  in  the  pur- 
pose for  which  the  proceeds  of  the  loan  are  to  be  used, 
provided  it  is  assured  of  payment  within  the  time  agreed 
upon.  A  manufacturer  or  any  other  business  man  is  as 
much  in  need  of  short-term  credit  for  certain  legitimate 
purposes  as  is  the  merchant.  A  bank  will  lend,  on  proper 
security,  as  readily  to  a  manufacturer  as  to  a  merchant. 
Even  if,  as  is  not  the  case,  the  bank  would  lend  its  credit 
only  for  the  promotion  of  transactions  facilitating  the 
movement  of  goods  towards  the  consumer,  there  can  be 


BANKING  615 

no  fundamental  distinction  made  between  conversion  of 
raw  materials  into  a  salable  product  and  the  movement 
of  such  a  product  from  the  point  of  production  to  the 
market.  If  one  is  a  legitimate  purpose  for  which  to  lend 
money,  so  is  the  other,  for  each  represents  a  necessary 
stage  in  the  process  of  production.  If  production  were 
halted  at  one  stage  it  would  be  checked  at  every  stage. 
The  essential  distinction  is  between  long-term,  or  incon- 
vertible, and  short-term,  or  convertible,  loans — not  be- 
tween the  purposes  of  the  loans.  The  commercial  bank 
has  adapted  its  mechanism  for  handling,  as  its  regulat 
business,  only  short-term  or  convertible  loans.  Having 
undertaken  the  task  of  supplying  short-term  credit,  its 
first  duty  is  to  take  care  of  the  legitimate  demands  which 
may  be  made  upon  it  for  short-term  credit.  When  the 
legitimate  demand  is  taken  care  of,  the  bank  may  employ 
the  balance  of  its  credit  as  it  pleases,  keeping  its  loans, 
however,  as  "liquid,''  or  convertible,  as  possible. 

Thus  we  find  the  private  commercial  bank,  which  is 
less  restricted  by  law  in  regard  to  its  investments  than 
are  incorporated  banks,  making  long-term  loans  when  it 
has  idle  funds,  or  even  buying  and  selling  long-term 
securities  for  profit — that  is,  for  the  sake  of  a  difference 
between  the  purchase  price  and  the  selling  price,  as  well 
as  for  the  interest  or  dividends  which  may  be  receivable. 

So  also,  when  the  merchant  or  the  manufacturer  goes 
to  the  bank  for  a  loan,  which  is  granted  by  the  bank 
ostensibly  as  a  commercial  loan,  for  the  furthering  of 
some  specific  commercial  transaction,  the  bank  does  not 
restrict  its  scrutiny  to  the  transaction  itself  as  a  source 
of  repayment,  but  looks  as  well  to  the  borrower's  financial 


6i6  PRINCIPLES  OF  BUSINESS 

statement,  particularly  with  respect  to  the  ratio  of  quick 
assets  to  current  liabilities.  It  the  borrower  has  a  large 
surplus  of  quick  assets  over  current  liabilities  he  will 
easily  get  his  loan  and  then  may  take  his  money  and  in- 
vest it  in  fixed  assets;  the  bank  does  not  know  nor  care, 
so  long  as  the  loan  is  paid  at  maturity.  In  short,  the 
borrower  has  a  legitimate  need  for  long-term  as  well  as 
for  short-term  credit;  he  borrows  both  kinds  of  credit, 
but  applies  the  funds  at  his  own  discretion,  arranging  his 
business  in  such  a  manner  that  his  loans,  whether  long- 
term  or  short-term,  will  be  paid  when  they  become  due.^ 

It  would  seem,  then,  that  the  purpose  of  the  commer- 
cial bank  cannot  be  said  to  be  strictly  to  supply  money 
for  commercial  transactions,  nor  strictly  to  make  short- 
term  loans,  but  rather  to  deal  in  readily  convertible  credit, 
which  may  be  long-term  or  short-term,  but  which  can  be 
converted  into  money  upon  short  notice. 

Loans  and  discounts. — Any  purchase  of  a  debt  con- 
stitutes in  effect  a  loan  to  the  debtor.  Whether  loans  are 
called  loans,  discounts,  or  purchases,  the  distinctions  be- 
tween them  are  chiefly  technical.  A  discount,  as  dis- 
tinguished from  other  loans,  is  the  purchase  of  credit 
with  interest  charges  paid  in  advance.  The  bank  "dis- 
counts" its  depositor's  paper,  and  "purchases"  the  paper 
of  outsiders. 

Classes  of  loans. — Loans  made  by  commercial  banks 
are  made  either  as  direct  loans  or  as  purchases  of  securi- 

1  "We  may  safely  conclude  that  50  per  cent  of  all  loans  of  national 
and  state  banks  and  trust  companies  is  devoted  to  investment  uses 
and  that,  including  direct  investments,  about  two-thirds  of  all  the 
credit  extended  by  commercial  banks  goes  for  fixed  rather  than 
for  working  capital." — H.  G.  Moulton,  Journal  of  Political  Econ- 
omy, June,  1918. 


BANKING  617 

ties.  Obviously,  the  purchase  of  a  security  is  merely  a 
loan. 

Direct  loans  may  be  classed  as  either  demand  loans  or 
time  loans,  and  as  secured  or  unsecured. 

"Purchase-loans''  may  be  broadly  divided  into  pur- 
chases of  acceptances  and  purchases  of  securities — stocks, 
bonds  and  also  promissory  notes.  The  purchaser  of 
shares  of  stock,  of  course,  becomes  a  part  owner  of  the 
issuing  corporation,  but  a  sale  of  stock  is,  in  effect,  a 
form  of  borrowing,  especially  if  the  stock  is  "preferred" 
stock — that  is,  stock  upon  which  a  stipulated  dividend  is 
to  be  paid,  if  earned.  Commercial  banks  normally  hold 
securities,  not  inclusive  of  Government  bonds,  in  an 
amount  equal  to  about  one-fifth  of  their  loans  and  dis- 
counts. 

Demand  loans. — Demand,  or  call,  loans  are  loans  pay- 
able upon  the  demand  of  the  lender;  or  at  any  prior  time, 
at  the  option  of  the  borrower.  They  are  made,  usually, 
upon  collateral  security  of  a  readily  convertible  type — 
often  to  brokers,  who  secure  their  working  capital  by 
means  of  this  class  of  loans,  on  stocks  and  bonds  as 
security.^ 

The  rate  of  interest  fluctuates  much  more  widely  on 
"call  money"  than  upon  time  loans.  The  reasons  for  this 
are  obvious — that  when  money  is  plentiful  a  temporary 
surplus  can  be  loaned  by  the  bank  "on  call;"  and  lending 
even  at  a  low  rate  of  interest  is  preferable  to  letting  the 
funds   remain   idle.     Again,    when   money   is   scarce,    a 

^Technically  a  "call  loan"  is  one  that  (l)  is  on  demand,  (2)  is 
secured  by  negotiable  collateral,  (3)  that  is  for  $5,000  or  more,  and 
(4)  that  is  made  by  a  bank  or  ])anker.  Such  loans,  under  the  law 
of  New  York,  where  they  are  most  frequently  made,  may  bear  any 
rate  of  interest  without  becoming  usurious. 


6i8  PRINCIPLES  OF  BUSINESS 

broker  or  other  borrower  who  may  find  it  vital  to  secure 
cash  for  temporar}'-  use  will  be  willing  to  pay  almost  any 
price  for  a  loan  to  tide  him  over  his  crisis. 

Call  loans  have  been  an  important  feature  of  our 
financial  system,  in  their  influence  upon  movements  of 
money  from  the  country  banks  to  the  financial  centers, 
particularly  to  New  York.  The  fact  that  a  market 'for 
idle  funds  could  be  found  in  New  York,  for  loans  to 
brokers  on  the  stock  exchange,  along  with  the  necessity 
of  keeping  funds  with  New  York  banks  to  meet  their 
demands  for  New  York  exchange,  led  banks  all  over  the 
country,  so  far  as  they  were  permitted  by  law,  to  keep 
a  large  part  of  their  reserves  with  New  York  banks;  for 
there  they  could  obtain  a  low  rate  of  interest  upon  their 
deposits,  whereas  in  their  own  vaults  the  reserves  would 
be  idle.  The  New  York  banks,  in  turn,  made  it  a  prac- 
tice to  lend  these  bankers'  deposits  as  demand  loans,  ob- 
taining a  higher  rate  of  interest  than  they  paid  the  coun- 
try banks.  Such  loans,  of  course,  had  to  be  in  such  a 
shape  as  would  make  it  possible  for  the  New  York  banks 
to  "call"  them  and  return  the  funds  to  the  country  banks 
on  demand. 

It  is  easy,  then,  to  see  how  a  financial  disturbance  might 
originate  in  New  York  and  affect  the  whole  country.  If 
the  New  York  banks  had  the  country  banks'  funds  lent 
to  brokers  who  failed — numbers  at  once — they  would 
have  difficulty  in  meeting  the  demands  for  the  return  of 
the  country  balances.  The  peril  inherent  in  such  a  situa- 
tion may  be  seen  when  it  is  realized  that  an  amount  equal 
to  approximately  70  per  cent  of  the  reserves  in  the  New 
York  and  Chicago  banks,  it  is  estimated,  has  been  lent  to 


BANKING  619 

brokeis  in  the  form  of  call  loans,  with  stocks  and  bonds 
as  security.  These  conditions  have  been  modified  by  the 
operation  of  the  Federal  Reserve  System,  which,  in  fact, 
was  brought  into  existence  largely  with  a  view  to  correct- 
ing the  maladjustments  resulting  from  such  a  concentra- 
tion of  reserves  in  the  larger  cities. 

It  will  be  observed  that  the  making  of  call  loans  is 
orthodox  commercial  banking  practice,  yet  with  respect 
to  the  use  made  of  the  funds  in  such  cases  as  were  men- 
tioned above,  there  seems  to  be  little  to  indicate  that  the 
practices  referred  to  were  primarily  of  the  nature  of  mer- 
cantile financing.  Even  if  we  grant  that  the  broker's 
business  is,  from  his  point  of  view,  a  commercial  one — 
the  dealing  in  securities  as  commodities — the  funds,  ex- 
cept in  so  far  as  they  contributed  to  the  broker's  profit, 
were  devoted  largely  to  speculative,  not  commercial,  pur- 
poses. 

Time  loans. — Time  loans,  of  a  maturity  period  of 
from  one  to  three  months,  are  the  typical  short-term 
credit  extended  by  the  commercial  bank.  In  these  we 
see  the  funds  which  enable  the  merchant  to  maintain  the 
continuity  of  his  operations.  He  purchases  goods  with 
the  credit  he  has  received  from  the  bank  in  exchange  for 
his  own  credit,  and  replenishes  his  supply  of  cre'dit  con- 
stantly in  advance  of  the  sale  of  his  merchandise  by  "de- 
positing" the  proceeds  of  his  sales — whether  such  pro- 
ceeds are  in  the  form  of  cash,  or  of  credit  instruments 
secured  from  his  customers.  Even  where  no  money  or 
credit  instrument  is  received  upon  the  making  of  a  sale, 
the  credit  being  in  the  form  of  a  book  account,  the  trans- 
fer of  the  customer's  credit  is  implied,  and  the  bank  is 


620  PRINCIPLES  OF  BUSINESS 

willing  to  consider  the  merchant's  possession  of  the  book 
account  an  asset  upon  which  credit  may  be  extended, 
although  it  is  only  rarely  that  the  actual  title  to  the  book 
credit  is  transferred  by  the  merchant  to  the  bank. 

Time  loans  without  collateral  may  be  made  to  the  de- 
positor upon  his  own  note  (single-name  paper),  or  upon 
a  note  secured  from  the  customer  and  indorsed  by  the 
merchant  (double-name  paper),  or  upon  the  merchant's 
note  indorsed  for  strengthening  by  a  friend  of  the  mer- 
chant (accommodation  paper). 

Time  loans  are  made  without  collateral  (pledge  of  se- 
curities) when  the  borrowers  financial  statement  indi- 
cates that  he  has  such  a  ratio  of  quick  assets  to  current 
liabilities  that  he  will  be  able  to  pay  his  note  without 
difficulty.  Again,  the  reason  for  lack  of  collateral  may 
be  that  the  borrower,  a  merchant,  for  example,  has  no 
suitable  collateral,  his  capital  being  in  the  form  of  a  stock 
of  goods.  Such  loans  are  made  only  to  borrowers  whose 
"moral"  or  "character"  rating  is  high. 

Time  loans  secured  by  collateral  are  made  when  there 
is  a  lack  of  certainty  as  to  the  borrower's  ability  to  pay 
— perhaps  because  the  funds  may  be  intended  for  the 
purchase  of  fixed  capital.  If  willingness  to  pay  is  in 
question,  the  loan  will  seldom  be  made  at  all.  If  not  for 
fixed  capital,  the  funds  may  be  for  purposes  of  specula- 
tion, or  for  purchase  of  goods  for  consumption,  not  for 
resale.  The  typical  collateral  is  stocks  and  bonds.  Typi- 
cal borrowers  for  speculative  purposes  are  financial 
houses  and  others  underwriting  or  marketing  securities. 

Acceptances, — Especially  since  the  esta1)lishment  of 
the  Federal  Reserve  Banks,  which  may  issue  notes  against 


%JOQ^_cmLz^ 


BANKING  621 


-77^  New  voRif.    AL>w*>>-^2/^Q/f^. 


ko.-'^tJy  ~C?o)  cCg^yO^    "^-^f"^^*^       ^ 

h^ ^nr«ij,A    to    p^   to       LADENBURG, 


C^AtfT 


'         for   talite   rectivt» 

THALMANN  &  CO.,  or  order,  at  their  offiet. 


No.  es  Bffiod  Street,  in  a«  City  of  Neto  Torle^ 


in-  United  Statet  Gold  Coin,  aith  interest  at  the  rate  of per  cent,  per  ann\./n,  having  deposited 

and  pledged  urith  them  as  collateral  security  for  payment  of  this  or  any  other  indebtedness  or  liability 

contracted  or  to  be  contracted,  duo  or  to  become  dtte  to  them, 

jTTW    <!Lc>,on^    i^et-<>yO_   /f-  /\.     O-vvc  .  (^  /3v 

0/  the  present  market  value  of  $    f^  ^  (^■^-<  ktv ,  J^    also  hereby  giving  to  them  a  lien  for  the 

imount  of  all  the  said  liabilities  upon  all  the  property  or  securities  at  'any  time  deposited  with  or 
left  in  their  possession  or  custody  by  or  for  ",  for  safe  keeping  or  otherwise  or  in  which  "7  have  any 
intere't  and  also  upon  any  credit  balance  or  deposit  account  however  arising,  which  "  from  time  to 
time  may  have  with  thsm. 

It  is  agreed  that  ^  may  from  time  to  time  exchange  any  security  held  by  them  in  whole  or 
in  part  for  another  or  others,  satisfactory  to  them,  and  that  they  may,  in  their  discretion,  require  the 
exchange  of,  or  a  suistitution  for,  all  or  any  part  of  the  same,  and  that  they  may  from  time  to  time 
demand  further  security  to  an  amount  they  may  deem  sufficient;  and  any  security  exchanged  or 
eubstiiuted  shall  in  all  respects  be  subject  to  all  and  singular  the  agreements  and  provisions  herein 
contained. 

j^  do  hereby  authnri-g  and  empower  them  at  their  option  at  any  time  to  appropriate  and 
apply  to  the  payment  and  extinguishment  of  any  of  flifl  above  named  obligations  and  liaiHities, 
ichether  now  existing  or  hereafter  contracted,  any  and  all  moneys  now  or  hereafter  in  their  hands 
en  deposit  or  otherwise  to  the  credit  of  or  belonging  to  Zr  whether  the  said  obligations  or  liabilities, 
are  then  due  or  not  due;  and  S-  further  agree  that  in  the  event  of  Zr  insolvency,  all  or  any  of  the 
said  obligations  and  liabilities  shall  at  their  option  become  and  be  immediately  due  and  payable 
without  demand  of  payment  thereof. 

It  is  further  agreed  on  failure  to  comply  with  any  of  the  provisions  herein  contained,  that 
they  may  declare  this  obligation  due,  and  whether  due  or  otherwise,  may  sell  the  whole  or  any  part 
of  the  said  securities,  including  any  exchanges,  substitutes  or  additions,  at  the  New  York  Stock 
Exchange,  or  at  any  Broker's  Board,  or  at-  public  or  private  sale,  without  notice  of  sale,  or  of  time  or 
place  of  sale,  without  demand  of  payment  and  without  advertisement,  unless  they  shall  elect  to  give 
luch  notice  or  notices,  or  to  demand  payment  or  to  adcertise.  which  or  any  of  which  they  may  do  or  omit 
at  their  election;  and  upon  any  such  sale  Uiey  may  bid  for  or  become  purchasers  of  the  whole,  or 
any  part  of  the  property  sold,  and  the  proceeds  of  any  such  sale,  less  the  proper  costs  and  expense* 
thereof,  shall  be  applied  first  to  the  discharge  of  this  obligation,  in  United  States  Oold  Coin,  and 
next  to  the  payment  of  any  one  or  more  of  any  other  of  said  liabilities  or  indebtedness  of  _Z-  to 
them  whether  then  due  or  not,  as  they  shall  deem  proper  or  they  may  hold  the  same  at  t\tir 
option  as  additional  security  against  any  liability  or  indebtedness  not  then  matured.  If  there  be  any 
ieficiency  7  promise  to  pay  the  same,  if  any  surplus,  the  amount  to  be  paid  over  to  ^  subject  to  tht 
above  provision  at  to  any  other  liability  or  indebtedness. 


;4^dr€6, 


COLLATERAL   TRUST    NOTE 


622  PRINCIPLES  OF  BUSINESS 

approved  commercial  paper,  the  trade  acceptance  and  the 
bankers'  acceptance  have  come  into  great  prominence. 
The  trade  acceptance  is  a  draft  which  the  purchaser  of 
goods  "accepts,"  or  agrees  to  pay.  The  bankers'  accept- 
ance is  a  draft  which  a  bank  has  accepted.  An  explana- 
tion of  acceptances  and  of  the  issue  of  currency  against 
them  will  be  found  in  the  brief  description  of  the  Federal 
Reserve  system,  in  the  next  chapter,  while  an  explana- 
tion of  the  use  of  acceptances  in  commercial  transactions 
will  be  found  in  the  chapter  on  "Credit." 

The  "line  of  credit." — Banks  give  a  depositor,  as  a 
rule,  a  line  of  credit  amounting  to  five  times  his  average 
balance  on  deposit.  The  theory,  as  usually  understood, 
is  that  by  his  depositing,  say,  $i,ooo,  the  bank  is  enabled 
to  make  loans  to  the  extent  of  $5,000,  the  depositor,  other 
things  being  equal,  being  given  the  preference.  The 
actual  situation,  however,  is  that  the  bank,  in  typical 
cases,  upon  receiving  the  borrower's  credit  and  money 
and  converting  it  into  its  own  credit,  lends  the  depositor 
an  amount  of  its  own  credit  equal  to  the  total  it  has  re- 
ceived— $5,000,  in  our  present  illustration — but  requires 
that  the  depositor  use  not  more  than  four-fifths  of  it, 
leaving  one-fifth  which  the  bank  may  use  as  a  reserve 
against  cash  demands — upon  which  the  bank,  however, 
receives  interest.  The  borrower  from  a  commercial  bank 
pays  a  rate  of  interest  20  per  cent  higher  than  that  of 
the  same  nominal  rate  paid  to  the  industrial  bank  or 
trust  company,  since  the  latter  holds  much  of  its  funds 
as  time  deposits,  against  which  a  one  per  cent  reserve  is 
sufficient  to  take  care  of-  cash  demands.  The  extra  rate 
of  interest  paid  to  the  commercial  bank  is,  however,  com- 


BANKING  62J 

pensated  for  by  the  value  of  the  convenient  checking  sys- 
tem, but  the  account  will  not  be  larger  than  the  borrower 
requires  as  a  reserve  against  his  check  payments ;  he  will 
secure  his  larger  funds,  if  need  be,  from  an  investment 
bank  or  trust  company,  or  through  a  note  broker,  in 
which  circumstances  he  can  use  the  whole  amount  of  the 
funds  derived  from  the  sale  of  his  credit. 

What  is  a  bankable  proposition? — The  question  is 
frequently  asked,  just  what  is  a  bankable  proposition? 
The  following  rules  may  be  laid  down.  It  is  not  pre- 
sumed to  dictate  that  a  bank  should  not  grant  a  loan  un- 
less all  these  elements  are  present,  but  they  should  be 
present  if  the  relations  between  the  bank  and  its  customer 
are  to  be  enduring  and  mutually  profitable. 

1.  The  loan  should  be  for  the  purpose  of  initiating  a 
transaction  which  will  be  consummated  in  the  ordinary 
course  of  business  within  a  reasonably  short  time,  the 
maximum  a  year. 

2.  The  borrower  should  be  in  a  position  to  liqui'date 
the  loan  even  if  the  specific  transaction  should  miscarry. 

3.  To  this  end  the  borrower  should  have  liquid  assets 
(exclusive  of  the  money  to  be  borrowed)  in  excess  of 
all  liquid  liabilities  (including  the  amount  of  the  loan), 
with  a  comfortable  margin  over.  Leaving  the  loan  out 
of  the  reckoning,  the  general  rule  is  that  liquid  assets 
should  be  double  the  amount  of  liquid  liabilities.  This 
rule,  however,  is  too  rigid  to  be  of  any  practical  value. 

4.  The  borrower  should  be  in  a  position  to  show  that 
he  is  conducting  a  profitable  business,  supplying  legitimate 
public  demands.  It  is  not  implied  that  the  business  must 
be  that  of  supplying  necessaries  only,  though  the  closer 


624  PRINCIPLES  OF  BUSINESS 

to  basic  needs  a  business  gets,  the  more  stable  is  it  likely 
to  be. 

5.  The  borrower  should  be  ready,  willing  and  able  to 
show  that  he  has  good  moral  character,  and  that  he  is 
reasonably  intelligent  in  business  affairs — that  he  pos- 
sesses native  shrewdness  and  good  judgment  and  that  he 
has  a  fair  understanding  of  business  methods  and  busi- 
ness principles. 

6.  The  borrower  should  be  ready  to  show  that  he  has 
sufficiently  protected  his  business  with  insurance. 

7.  The  borrower  should  be  ready  to  show  that  he  is 
subject  to  no  excessive  contingent  liabilities  or  hazards 
such  as  might  be  created  by  his  accommodation  endorse- 
ment of  outside  paper  or  by  his  being  involved  in  specula- 
tive engagements. 

If  a  business  man  can  show  these  elements  he  has  a 
right  to  banking  accommodation,  and  should  not  rest 
content  till  he  gets  it,  uses  it  and  satisfies  the  obligation 
it  creates. 

The  clearing  house. — Before  entering  upon  our  sub- 
sequent brief  examination  of  the  several  classes  of  com- 
mercial banks,  we  may  at  this  point  describe  the  method 
by  which  banks  adjust  among  themselves  the  accounts 
created  when  they  "cash"  for  each  other  the  checks  of 
depositors.  This  adjustment  of  accounts  is  accomplished 
through  the  "clearing  house." 

A  clearing  house  association  is  an  association  of  banks, 
for  the  purpose  of  maintaining  a  clearing  house,  where 
accounts  of  one  bank  against  the  other  may  be  adjusted. 
The  principal  adjustments  are  of  depositors'  checks;  when 
these  are  sent  to  the  clearing  house  they  are  credited  to 


BANKING  625 

the  collecting  bank  and  debited  to  the  paying  bank,  the 
totals  added  up,  and  settlements  of  differences  made  in 
clearing  house  certificates,  U.  S.  gold  certificates,  legal 
tender  notes,  or  gold  coin.  The  use  of  the  clearing  house 
certificates  is  in  the  transfer  of  credits  to  funds  which 
may  be  kept  at  the  clearing  house  in  gold  coin,  each 
member  keeping  a  balance  on  deposit.  Checks  credited 
to  and  charged  against  each  bank  will  nearly  balance  eajh 
other,  and  collections  are  accomplished,  accordingly,  prm- 
cipally  by  bookkeeping. 

If,  for  example,  there  were  only  two  banks,  A  and  B, 
in  the  clearing  association,  it  can  readily  be  seen  how  A 
might  hold  $1,000  in  checks  drawn  against  B,  while  B 
might  hold  $1,000  in  checks  drawn  against  A.  Simply 
by  exchanging  checks,  settlement  would  be  made.  If 
B,  however,  held  checks  to  the  amount  of  $1,100,  A 
would  be  required  to  transfer  to  B  $100  in  cash.  The 
principle,  of  course,  remains  the  same,  no  matter  how 
many  banks  compose  the  association — cross  accounts  be- 
ing settled  not  by  cancelling  individual  accounts  against 
each  other,  however,  but  by  cancellation  of  totals  as  be- 
tween each  bank  and  the  clearing  house. 

The  distinction  between  clearings  and  collections,  it 
may  be  explained,  is  that  the  term  "clearing''  is  reserved 
for  collections  made  by  offsetting  checks  drawn  on  differ- 
ent banks,  one  against  the  other.  Where  there  is  no 
clearing  house,  checks  must  be  collected  by  being  sent  to 
the  debtor  bank,  which  then  remits  the  proceeds. 

Private  commercial  banks. — The  classes  of  commer- 
cial banks  of  which  we  may  now  give  a  brief  description 
are:     private   banks,    State   banks   and   national    banks. 


626  PRINCIPLES  OF  BUSINESS 

Private  banks  are  conducted  by  individuals  or  partner- 
ships, and  are  usually  allowed  a  considerable  latitude  in 
their  operations,  although  they  are  generally  under  State 
supervision  or  regulation.  Private  banks  of  the  com- 
mercial type  are  found,  as  a  rule,  only  in  the  smaller 
communities,  which  are  not  strong  enough  to  support  a 
state  or  national  bank — since  the  state  or  national  bank 
njust  have  a  minimum  capital  prescribed  by  statute,  rang- 
ing from  $25,000  in  the  case  of  any  national  bank  down 
to  amounts  rarely  as  low  as  $5,000  in  the  case  of  State 
banks.  Even  in  the  larger  towns,  however,  private  banks 
are  to  be  found  that  have  been  established  in  earlier  days 
and  still  maintain  themselves  in  competition  with  the 
newer  incorporated  institutions.  The  prestige  resulting 
from  many  years  of  successful  operation  goes  far  toward 
offsetting  the  greater  inherent  advantages  in  security 
possessed  by  State  and  national  banks.  It  seems  prob- 
able, however,  that  with  the  passing  of  the  present  estab- 
lished private  commercial  banks  the  class  will  almost  if 
not  entirely  disappear.  In  the  larger  cities,  as  noted 
above,  the  private  bankers,  except  the  larger  ones,  rarely 
attempt  to  do  a  commercial  business,  but  deal  in  stocks, 
bonds  and  investments  generally,  as  well  as  in  foreign 
loans  and  exchange.  It  will  be  recalled  how  certain 
private  bankers,  for  example,  negotiated  immense  loans 
to  foreign  governments,  prior  to  the  entrance  of  the 
United  States  into  the  European  War  and  the  consequent 
assumption  of  the  burden  of  war  financing  by  the  Govern- 
ment itself. 

State    banks. — State    banks    are    banks    incorporated 
under  the  laws  of  States,  as  distinguished  from  national 


BANKING  627 

banks,  which  operate  under  Federal  charters,  and  from 
private  banks,  which  are  unincorporated. 

State  banks,  as  a  rule,  may  be  organized  under  fewer 
restrictions  than  national  banks,  and  with  less  capital. 
They  are  permitted  a  wider  ra«ngeof  activities  and,  con- 
sequently, have  maintained  a  position  of  first  importance 
with  respect  to  their  numbers  and  are  but  Httle  behind 
the  national  banks  with  respect  to  the  volume  of  business 
done.  About  one-half  the  banking  power  of  the  coun- 
try is  held  by  State  banks,  and  their  number  is  three  times 
that  of  the  national  banks.  In  a  number  of  the  Western 
States,  laws  have  been  enacted  providing  for  the  guaranty 
or  insurance  of  demand  deposits  of  State  banks,  each 
bank  contributing,  pro  rata,  to  a  fund  maintained  for  the 
protection  of  the  solvency  of  any  member  institution,  with 
respect  to  its  demand  deposits.  Since  national  banks  are 
not,  as  a  rule,  eligible  to  participation  in  such  a  plan,  quite 
an  impetus  has  been  given  to  the  increase  of  State  banks 
at  the  expense  of  national  banks. 

In  view  of  the  need  for  mobilization  of  the  banking 
resources  of  the  country,  several  "drives"  have  been  made 
with  the  object  of  inducing  State  banks  to  come  into  the 
Federal  Reserve  system,  but  until  recently  no  appreciable 
number  had  joined,  and  even  yet  by  far  the  greater  num- 
ber remain  outside. 

It  is  not  to  be  doubted  that  the  State  banks  recognize 
the  value  of  membership  in  the  Federal  Reserve  system, 
especially  in  view  of  the  growing  use  of  acceptances, 
which  can  be  handled  to  better  advantage  by  member  than 
by  non-member  banks,  but  it  would  seem  that  each  bank 
has  its  individual  reasons  for  neglecting  or  deferring  the 


628  PRINCIPLES  OF  BUSINESS 

entering  of  the  new  system.  Among  these  reasons  may 
be  mentioned :  inabihty  to  comply  with  the  increased 
capital  requirements;  aversion  to  the  restrictions  upon  the 
amounts  which  member  banks  may  lend  to  individuals, 
and  to  the  restrictions  upon  the  security  upon  which  loans 
may  be  made;  increased  cost  of  operation;  and  reluctance 
to  accept  the  strict  Federal  supervision  imposed  upon 
member  banks.  Moreover,  many  of  the  advantages  of 
the  system  may  be  had  without  formal  membership,  espe- 
cially with  respect  to  clearing  and  collection  facilities. 
Despite  the  hesitation,  however,  which  State  banks  have 
evinced  in  regard  to  joining  the  system,  it  is  confidently 
assumed  that  sooner  or  later  the  entire  commercial  bank- 
ing business  of  the  country  will  be  unified  under  the 
Federal  Reserve  system  as  it  develops. 

National  banks. — The  national  banking  system  of  the 
United  States  was  established  by  the  passage  of  the 
National  Bank  Act  in  1863,  radically  amended  in  the 
following  year.  The  purpose  of  the  Act  was  to  provide 
a  market  for  Government  bonds  and  a  satisfactory  cur- 
rency. The  banks  were  to  purchase  bonds  and  issue 
notes  against  them  as  security.  It  was  expected  that  the 
State  banks  would  join  the  new  system,  but  so  few  of 
them  did  so  voluntarily  that  in  1865  a  tax  of  10  per  cent 
was  imposed  on  notes  issued  by  State  banks.  Since  the 
issue  of  notes  was  at  that  time  a  profitable  part  of  a 
bank's  business,  large  numbers  of  State  banks  were  by 
this  means  forced  to  incorporate  under  Federal  charters. 

Under  the  National  Bank  Act,  a  national  bank  is  per- 
mitted to  receive  deposits;  to  discount  promissory  notes, 
drafts,  bills  of  exchange,  and  other  evidences  of  debt,  to 


BANKING  629 

buy  and  sell  exchange,  coin  and  bullion,  to  lend  on  per- 
sonal security;  and  to  exercise  other  functions  incident 
and  necessary  to  the  carrying  on  of  a  banking  business. 

The  limitations  and  restrictions  upon  national  banks, 
with  respect  to  their  capital  and  the  nature  and  extent  of 
the  loans  which  they  are  permitted  to  make,  have  operated 
to  prevent  them  from  monopolizing  the  banking  field,  as 
noted  above,  but  these  restrictions  have  at  the  same  time 
been  influences  making  for  safety  and  conservatism.  The 
banks  which  have  preferred  to  operate  under  State  char- 
ters or  as  private  concerns  have  been  compelled,  by  the 
competition  of  the  national  banks,  to  offer  their  depositors 
at  least  an  approximately  equal  degree  of  safety. 

The  capital  requirements  for  the  organization  of  na- 
tional banks  are:  a  minimum  of  $25,000,  in  any  case; 
in  towns  of  3,000  to  6,000  inhabitants,  at  least  $50,000; 
in  towns  of  a  population  of  more  than  6,000  and  less  than 
50,000,  $100,000;  in  cities  of  over  50,000,  $200,000. 
One-half  of  the  capital  must  be  paid  in,  and  the  balance 
at  the  rate  of  not  less  than  10  per  cent  a  month.  There 
is  no  maximum  limit. 

The  capital  of  a  national  bank  may  not  be  or  remain 
impaired  for  a  period  of  more  than  three  months,  under 
penalty  of  being  closed  by  the  Comptroller  of  the  Cur- 
rency. Liabilities  may  not  be  contracted  in  excess  of  its 
capital,  except  for  circulating  notes,  deposits,  drafts  on 
its  own  funds,  and  unpaid  dividends.  Not  more  than  10 
per  cent  of  its  capital  and  surplus  may  be  lent  to  one  per- 
son, firm  or  corporation.  Only  such  real  estate  may  be 
permanently  owned  as  is  necessary  in  its  own  business  as 
a  bank;  real  estate  acquired  by  foreclosure  and  similar 


630  PRINCIPLES  OF  BUSINESS 

means  must  be  disposed  of  within  five  years.  National 
banks  may  now,  under  certain  restrictions,  make  loans 
upon  real  estate  security,  the  amount  so  lent  not  to  exceed 
50  per  cent  of  the  actual  value  of  the  property;  not  to 
exceed  25  per  cent  of  the  bank's  capital  and  surplus,  or 
33  1-3  per  cent  of  its  time  deposits.  Such  loans  may  run 
for  a  maximum  period  of  five  years  on  farm  land,  and  one 
year  on  other  real  estate.  The  making  of  such  loans  is 
confined  to  banks  outside  of  central  reserve  cities  and  to 
property  situated  within  100  miles  of  the  bank. 

The  most  notable  recent  developments  affecting  na- 
tional banks  are  those  of  the  Federal  Reserve  system, 
established  in  191 3,  especially  the  provisions  of  the  new 
system  relating  to  rediscount  of  commercial  paper.  A 
brief  description  of  the  important  features  of  the  Federal 
Reserve  system  is  given  in  the  following  chapter. 


CHAPTER    XXVII 

BANKING 

(Continued) 

THE  FEDERAL  RESERVE  SYSTEM 

Bankers'  banks. — The  Federal  Reserve  system  is 
primarily  a  system  of  bankers'  banks,  formed  for  the 
purpose  of  supplying  credit  to  commercial  banks,  which 
credit  is  distributed  by  the  commercial  banks  to  their 
depositors.  The  raw  materials  of  credit  are,  in  the  first 
instance,  supplied  by  the  depositors,  but  as  between  the 
commercial  banks  and  the  bankers'  banks,  commercial 
bank  credit  is  a  raw  material  to  be  sold  to  the  superior 
banks  and  by  them  resold  in  exchangeable  form  to  the 
commercial  banks.  The  Federal  Reserve  banks  deal  only 
with  the  Government,  and  with  other  banks,  except  that 
they  may  buy  commercial  paper  on  the  open  market. 

Origin  of  the  Federal  Reserve  system. — The  Fed- 
eral Reserve  System  was  established  by  the  Federal  Re- 
serve Act,  signed  by  President  Wilson  on  December  23, 

1913- 

Two  plans  had  been  considered — that  of  a  single  cen- 
tral bank,  and  that  of  a  number  of  regional  banks  of 
equal  rank.  The  latter  plan  was  adopted,  for  two  prin- 
cipal reasons:  (i)  to  avoid  the  sectional  jealousy  and  re- 
sentment which  would  have  been  felt  toward  the  favored 
district  in  which  one  central  bank  might  have  l^een  estab- 
Hshed;  and  (2)  to  avert  the  question  of  too  intimate  a 

6.^1 


632  PRINCIPLES  OF  BUSINESS 

governmental  control,  which  would  in  the  greatest  prob- 
ability have  been  raised,  if  one  bank  only  had  been  placed 
at  the  head  of  the  system.  An  additional  purpose  may 
have  been  to  destroy  the  centralization  of  banking  power 
in  the  hands  of  bankers  themselves,  which  had  led  to 
apparent  evils  under  the  former  system.  The  new  sys- 
tem provides,  of  course,  for  a  centralized,  but  impartial 
control,  exercised  by  the  Federal  Reserve  Board. ^ 

Twelve  "Federal  Reserve"  banks,  co-ordinate  in  rank, 
accordingly  were  established,  each  with  an  authorized 
minimum  capital  of  $4,000,000.  Provision  was  made 
for  initial  subscriptions  to  the  stock  by  the  Government 
and  by  the  public,  this  stock  to  be  redeemed  and  cancelled 
when  the  "member  banks"  should  have  subscribed  the 
required  amount.  All  national  banks  were  compelled  to 
become  members,  under  penalty  of  forfeiture  of  their 
charters.  Other  banks  may  become  members  by  comply- 
ing with  the  requirements. 

The  twelve  reserve  banks  are  operated  under  the  man- 
agement of  local  officers  and  boards  of  directors,  but  are 
all  subject  to  the  authority  of  the  Federal  Reserve  Board. 
Each  has  its  own  geographical  "reserve  district,"  the 
twelve  districts  together  comprising  the  continental 
United  States,  exclusive  of  Alaska.  Branches  are  author- 
ized and  have  been  established,  both  within  the  districts 
and  in  foreign  countries,  particularly  in  the  Latin-Ameri- 
can countries. 

1  The  Federal  Reserve  Board  consists  of  seven  members — two 
being  the  Secretary  of  the  Treasury  and  the  Comptroller  of  the 
Currency,  and  five  being  selected  by  the  President  of  the  United 
States,  with  "due  regard  to  a  fair  representation  of  the  different 
commercial,  geographical  and  industrial  divisions  of  the  country." 
The  Senate  assists  the  President  in  the  selection  of  these  five  mem- 
bers, and  confirms  their  appointment. 


BANKING  633 

Disposition  of  earnings, — The  earnings  of  the  re- 
serve banks  are  disposed  as  follows :  a  6  per  cent  annual 
cumulative  preferred  dividend  is  paid  on  the  shares  of 
stock  (par  value  $100),  which  stock  is  held  by  member 
banks ;  the  remainder  of  the  earnings  is  paid  to  the  United 
States  as  a  franchise  tax,  except  that  one-half  of  the 
earnings  of  each  reserve  bank  in  excess  of  the  preferred 
dividends,  which  are  a  first  claim  upon  its  earnings,  are 
devoted  to  the  creation  and  maintenance  of  a  surplus  fund 
equal  to  40  per  cent  of  its  paid-in  capital  stock.  The 
earnings  received  by  the  United  States  as  a  "franchise 
tax"  may  be  used,  at  the  discretion  of  the  Secretary  of 
the  Treasury,  to  supplement  the  gold  reserve  against  out- 
standing notes  or  to  reduce  the  outstanding  bonded  in- 
debtedness of  the  United  States. 

Objects  of  the  Federal  Reserve  System. — A  new 
system  of  banking  was  made  imperative  by  the  defects 
which  were  inherent  in  the  old  system.  It  was  apparent 
that  the  new  system  to  be  established  would  provide,  if 
it  were  to  be  satisfactory,  (i)  mobility  of  reserves;  (2) 
adjustability  or  "elasticity"  of  currency.^ 

By  mobility  of  reserves  is  meant  the  possibility  of 
shifting  reserves  of  money  to  the  points  where  demands 
for  money  might  be  most  insistent.  It  is  scarcely  neces- 
sary to  point  out  the  fact  that  the  lack  of  mobility  of 

1  The  terms  "elasticity"  and  "flexibility"  have  been  used  to  denote 
the  quality  desired  in  the  supply  of  credit.  "Adjustability"  expresses 
more  accurately  the  meaning  intended,  for  "elasticity"  suggests  ex- 
pansion and  subsequent  contraction  of  a  given  amount  of  credit, 
while  "flexibility"  suggests  a  change  of  position.  The  idea  of  change 
of  position,  is  included  in  the  term  "mobility."  What  is  actually 
meant  is  an  increase  or  decrease  in  the  supply  of  manufactured  or 
exchangeable  credit,  not  having  any  normal  or  fixed  quantity  as  a 
base,  but  determined  solely  by  the  current  needs  of  business. 


634  PRINCIPLES  OF  BUSINESS 

reserves  was  a  conspicuous  feature  of  the  obsolete  system. 
As  a  rule,  the  greater  became  the  demand  for  money,  the 
less  the  amount  of  money  which  was  to  be  had,  even  for 
sound  and  legitimate  enterprises. 

By  adjustability  of  the  currency  supply,  is  meant  the 
possibility  of  adjusting  the  amount  of  "money"  in  cir- 
culation to  the  amount  required  for  the  legitimate  needs 
of  business.  This  is  accomplished  through  the  creating 
of  credit  currency  to  supplement  gold  or  legal  tender. 
Federal  Reserve  notes,  bank  notes,  and  deposits  subject 
to  check  are  typical  forms  of  credit  currency. 

In  brief,  the  adjustment  of  the  supply  of  exchange- 
able credit — which  term  implies  convertible  credit — is 
accomplished  by  the  issue  of  Federal  Reserve  notes  in  ex- 
change for  commercial  paper  conforming  to  the  specific 
requirements  of  "eligibility"  applying  to  such  paper.  In 
order  to  assure  the  exchangeability  of  these  Federal  Re- 
serve notes,  they  are  made  convertible — that  is,  redeem- 
able in  gold  on  demand  at  the  United  States  Treasury 
Department,  or  in  gold  or  lawful  money  at  any  Federal 
Reserve  bank. 

Federal  Reserve  notes,  like  other  substitutes  for  money, 
are  in  reality  no  more  than  evidences  of  credit,  or  pur- 
chasing power,  which  has  been  formally  pledged — the 
possession  of  the  note  entitling  the  holder  to  exercise  the 
purchasing  power  inherent  in  the  capital  assets  which 
have  been  pledged. 

To  assure  the  convertibility  of  the  notes,  each  note 
bears  on  its  face  the  authority  for  its  conversion,  and  the 
promise  of  the  United  States  that  a  demand  for  conver- 
sion will  be  honored.     To  make  certain  the  redemption 


BANKING  635 

of  this  promise,  a  reserve  in  gold  is  carried  at  the  Treas- 
ury Department  at  Washington,  sufficient  to  meet  any 
demands  for  conversion  that  may  ordinarily  be  made. 

Theoretically,  the  adjustability  of  the  Reserve  note 
supply  is  limited  by  the  fact  that  the  notes  are  not  only 
redeemable  in  gold  but  also  issuable  against  gold  as  well 
as  against  short-term  paper.  The  ultimate  supply  of 
notes  is,  evidently,  limited  by  the  amount  of  gold  which 
can  be  secured  as  a  reserve,  and  not  by  the  legitimate 
needs  of  business  only.  This  defect,  however,  is  prob- 
ably more  theoretical  than  practical,  as  the  supply  of  gold, 
apparently,  is  ample. 

The  "member  banks." — All  national  banks  are  mem- 
bers of  the  Reserve  system,  each  member  bank  subscrib- 
ing to  stock  of  the  Reserve  bank  of  its  district  to  the 
amount  of  six  per  cent  of  its  own  capital  and  surplus. 
Other  banks  may  become  members  by  compliance  with  the 
rules  laid  down  as  to  capitalization,  lending,  and  other 
matters  which  are  obligatory  upon  national  banks.  To 
become  a  member,  accordingly,  a  State-controlled  bank 
does  not  need  to  change  its  form  of  organization,  but 
merely  subscribes  to  the  required  amount  of  stock  of  the 
Reserve  bank  and  subjects  itself  to  the  authority  of  the 
Federal  Reserve  Board.  The  regulations  of  the  Board, 
however,  as  to  the  loans  which  may  be  made  to  individ- 
uals— with  respect  to  the  amounts  of  such  loans  as  well 
as  the  security  which  may  be  accepted  as  collateral,  have 
operated  to  prevent  a  general  acceptance  of  the  system  by 
the  State  and  other  outside  banks.  In  any  case,  the  State 
banks  profit  by  the  operation  of  the  system,  both  as  a 
result  of  the  improved  financial  conditions  prevailing  and, 


636  PRINCIPLES  OF  BUSINESS 

specifically,  with  respect  to  their  use  of  the  facilities  pro- 
vided by  the  system  for  clearings  and  collections. 

Operation  of  the  Federal  Reserve  system., — The 
operation  of  the  Federal  Reserve  system  could  not  be  de- 
scribed with  any  degree  of  adequacy  within  our  limited 
space.  We  cannot,  however,  omit  a  very  brief  outline 
of  the  following  vital  features  of  the  system : 

1.  Reserves  against  deposits 

(a)  Reserves  of  reserve  banks 

(b)  Reserves  of  member  banks 

2.  Federal  Reserve  notes 

(a)  Rediscount  of  approved  commercial  paper 

(b)  Issue  of  notes 

(c)  Resen^es  for  protection  of  notes 
Reserves  of  reserve  banks  held  against  deposits. — 

Each  of  the  twelve  reserve  banks  may  receive  deposits, 
subject  to  certain  provisions,  restrictions,  and  limitations, 
from  the  Government  of  the  United  States,  from  mem- 
ber banks,  from  non-member  banks,  and  from  other  re- 
serve banks.  Against  these  deposits  the  reserve  bank 
must  hold  a  reserve  of  35  per  cent  in  gold  or  lawful 
money. 

Reserv'es  may  be  strengthened  ( i )  by  additional  de- 
posits (of  which  35  per  cent  serves  as  a  reserve  against 
the  new  deposit  and  65  per  cent  as  an  increase  of  reserves 
against  other  deposits),  and  (2)  by  increase  of  cash  re- 
sources due  to  reduction  of  loans  and  discounts  or  in- 
vestments in  securities. 

Since  the  reserve  banks  may  be  the  repositories  of  all 
Treasury  funds  except  the  required  reserves  which  the 
Treasury  must  maintain  as^ainst  its  own  obligations,  in- 


BANKING  637 

eluding  the  gold-redemption  fund,  the  Secretary  of  the 
Treasury,  who  controls  the  disposition  of. Treasury  funds, 
may  strengthen  the  reserves  of  any  reserve  bank  simply 
by  depositing  Treasury  funds  therein  or  by  checking  into 
them  funds  out  of  a  reserve  bank  which  has  a  superfluity 
of  reserves.  Any  reserve  bank,  moreover,  may  com.e  to 
the  aid  of  any  other  reserve  bank,  by  rediscoimting  its 
discounted  paper — in  fact,  may  be  required  to  do  so,  by 
the  affirmative  vote  of  five  members  of  the  Federal  Re- 
serve Board.  The  rates  for  such  rediscounting  are  fixed 
by  the  Board.  By  these  means  mobility  of  reserves  is 
assured. 

Cash  resources  may  be  increased  also  ( i )  by  sale  of 
"earning  assets,"  and  (2)  by  raising  the  rates  of  interest 
and  discount,  thus  reducing  the  demand  for  loans  and  so 
increasing  the  ratio  of  cash  resources  to  loans  and  dis- 
counts. 

Reserves  of  member  banks. — Each  member  bank 
must  establish  and  maintain  with  the  Federal  Reserve 
bank  of  its  district  reserves  as  follows:  (a)  If  not  in  a 
reserve  or  central  reserve  city,  7  per  cent  of  the  aggregate 
amount  of  its  demand  deposits  (deposits  payable  within 
30  days)  and  3  per  cent  of  its  time  deposits,  (b)  If  in 
a  reserve  city,  10  per  cent  of  its  demand  deposits  and 
3  per  cent  of  its  time  deposits,  (c)  If  in  a  central  re- 
serve city,  13  per  cent  of  its  demand  deposits  and  3  per 
cent  of  its  time  deposits.^ 

1  Under  the  National  Banking  Act.  New  York,  Chicago  and  St. 
Louis  were  designated  as  "central  reserve  cities" ;  certain  other  cities 
were  designated  as  "reserve  cities,"  wliile  banks  in  places  not  included 
as  "central  reserve"  or  "reserve"  cities  were  designated  as  "country 
banks."  The  term  "reserve  city"  is  not  to  be  confused  with  "Federal 
Reserve  city,"  which  means,  a  city  where  a  Federal  Reserve  bank 
is  established. 


638  PRINCIPLES  OF  BUSINESS 

Member  banks  may  increase  their  reserves  by  redis- 
counting  "eligible"  paper  at  the  reserve  banks  of  their 
respective  districts  or  by  raising  their  rates  of  interest  and 
discount,  which  lessens  the  demand  for  loans,  so  that  as 
existing  loans  are  repaid,  the  cash  received  tends  to 
remain  in  the  bank  instead  of  being  put  out  again  in  the 
form  of  new  loans. 

It  may  be  remarked  that,  so  far  as  the  reserves  of  the 
member  banks  are  concerned,  the  possibility  of  increase 
of  their  cash  resources  through  the  rediscount  of  ap- 
proved commercial  paper — that  is,  paper  conforming  to 
the  rediscounting  requirements — at  the  reserve  banks  is 
practically  unlimited. 

Federal  Reserve  notes. — The  Federal  Reserve  notes 
issued  by  reserve  banks  are,  apparently,  destined  com- 
pletely to  supplant  bank  notes,  including  Federal  Reserve 
bank  notes, ^  as  a  substitute  for  money,  and  possibly,  at 
some  time  in  the  future,  also  the  United  States  notes,  or 

^  Federal  Reserve  bank  notes  are  notes  issued  by  reserve  banks 
against  their  holdings  of  U.  S.  bonds.  Under  a  recent  ruling  the 
reserve  banks  may  take  over  from  the  national  banks  at  par  the 
2  per  cent.  U.  S.  bonds  held  by  the  national  banks,  taking  with  the 
bonds  the  note  issue  privilege  attaching  to  the  bond  in  the  hands  of 
the  national  bank.  The  national  banks  are  thus  enabled  to  dispose 
of  these  bonds  at  par — to  an  amount  not  exceeding  $25,000,000, 
however,  in  any  one  year.  The  reserve  banks,  at  their  option,  may 
convert  these  two  per  cent,  bonds  with  the  circulation  (i.e.,  note 
issue)  privilege  into  three  per  cent,  bonds  without  the  circulation 
privilege.  Before  making  such  an  exchange,  of  course,  the  notes 
outstanding  against  the  two  per  cent  bonds  must  be  retired.  This 
is  accomplished  in  the  same  way  as  the  retirement  of  national  bank 
notes.  Comparatively  few  Federal  Reserve  bank  notes  have  been 
issued,  but  the  number  will  be  increased,  at  least  temporarily  by 
the  present  policy  of  retiring  silver  certificates  and  issuing  reserve 
bank  notes  in  place  of  them.  This  is  being  done  in  order  that  the 
silver  coins  held  against  the  certificates  may  be  melted  and  shipped 
abroad  in  settlement  of  trade  balances,  there  being  at  present  an 
embargo  on  the  shipment  of  gold. 


BANKING  639 

"greenbacks,"  of  which  $346,000,000  have  been  outstand- 
ing since  1879/ 

Federal  Reserve  notes  are  the  "elastic"  currency  so 
long  desired — not  quite  so  elastic,  however,  as  was  hoped 
for  by  the  more  radical  proponents  of  a  new  banking 
measure,  the  need  for  which  led  to  the  passage  of  the 
Federal  Reserve  Act.  While  redeemable  in  gold,  these 
notes,  in  the  volume  of  exchangeable  credit  which  they 
represent,  vary  in  amount  with  the  varying  needs  of  busi- 
ness for  a  credit  medium  of  exchange. 

The  provisions  of  the  Act,  together  with  the  Amend- 
ments of  June  21,  1917,  relating  to  the  issue  of  Federal 
Reserve  notes,  are  in  part  as  follows — slight  changes  in 
punctuation  being  made  for  the  sake  of  clearness : 

Authorization  and  issue  of  Federal  Reserve  notes. 
— Sec.  16.  "Federal  Reserve  notes,  to  be  issued  at  the 
discretion  of  the  Federal  Reserve  Board  for  the  purpose 
of  making  advances  to  Federal  Reserve  banks  through 
the  Federal  Reserve  agents  as  hereinafter  set  forth  and 
for  no  other  purpose,  are  hereby  authorized.  The  said 
notes  shall  be  obligations  of  the  United  States  and  shall 
be  receivable  by  all  national  and  member  banks  and  Fed- 
eral Reserve  banks  and  for  all  taxes,  customs  and  other 
public  dues.  They  shall  be  redeemed  in  gold  on  demand 
at  the  Treasury  Department  of  the  United  States,  in  the 

1  "Greenbacks,"  or  United  States  notes,  were  first  issued  during 
the  Civil  War.  Following  a  period  of  fluctuation  in  value,  due  to 
lack  of  provision  for  redemption  in  specie,  it  was  provided  in  1879 
that  no  more  greenbacks  should  be  issued,  but  that  the  amount  out- 
standing, as  shown  by  the  books  of  the  Government  ($346,681,016), 
should  be  kept  in  circulation,  redeemable  in  specie,  but  reissued  as 
soon  as  redeemed.  As  a  reserve  against  demands  for  redemption  a 
special  fund  of  $150,000,000  in  gold  is  set  aside  in  the  Treasury  at 
Washington. 


640  PRINCIPLES  OF  BUSINESS 

city  of  Washington,  District  of  Columbia,  or  in  gold  or 
lawful  money  at  any  Federal  Reserve  bank. 

"Any  Federal  Reserve  bank  may  make  application  to 
the  local  Federal  Reserve  agent  for  such  amount  of  the 
Federal  Reserve  notes  hereinbefore  provided  as  it  may 
require.  Such  application  shall  be  accompanied  with  a 
tender  to  the  local  Federal  Reserve  agent  of  collateral  in 
amount  equal  to  the  sum  of  the  Federal  Reserve  notes 
thus  applied  for  and  issued  pursuant  to  such  application. 
The  collateral  security  thus  offered  shall  be  notes,  drafts, 
bills  of  exchange,  or  acceptances  acquired  under  the  pro- 
visions of  section  thirteen  of  this  Act ;  or  bills  of  exchange 
indorsed  by  a  member  bank  of  any  Federal  Reserve  dis- 
trict and  purchased  under  the  provisions  of  section  four- 
teen of  this  Act ;  or  bankers'  acceptances  purchased  under 
the  provisions  of  said  section  fourteen;  or  gold  or  gold 
certificates ;  but  in  no  event  shall  such  collateral  security, 
whether  gold,  gold  certificates,  or  eligible  paper,  be  less 
than  the  amount  of  Federal  Reserve  notes  applied  for." 

In  the  foregoing  paragraph  it  will  be  noted  that  pro- 
vision is  made  for  the  issue  of  Federal  Reserve  notes 
directly  against  gold.  While  the  notes  can  be  issued  in 
such  a  case  only  against  gold  of  value  equal  to  the  face 
value  of  the  notes,  when  the  notes  are  so  issued  only  40 
per  cent  of  the  gold  against  which  the  notes  are  issued  is 
required  to  be  held  in  reserve,  the  remaining  60  per  cent 
serving  as  a  reserve  against  other  liabilities  of  the  issuing 
bank — as  against  notes  issued  against  commercial  paper, 
for  example.  This  provision  is  of  far-reaching  importance, 
and  is  in  part  the  cause  and  in  part  the  result  of  the  policy 
of  the  Federal  Reserve  system  of  accumulating  in  the 


BANKING  .     641 

vaults  of  the  reserve  banks  as  large  a  supply  of  gold  as 
possible.  The  most  inobservant  reader  will  have  re- 
marked the  recent  disappearance  of  gold  certificates,  or 
"yellow-backs,"  from  circulation  and — in  parts  of  the 
country  where  gold  was  formerly  current — of  gold  itself. 
The  Federal  Reserv^e  notes  are,  it  is  true,  redeemable  in 
gold,  but  only  on  demand  at  the  Treasury  Department. 
They  are  redeemable  in  gold  or  lawful  money,  however, 
at  any  reserve  bank.  It  seems  necessary,  in  the  judg- 
ment of  bankers  and  economists,  to  maintain  gold  as  the 
only  money,  and  to  let  all  substitutes  for  money  be  re- 
deemable in  gold.  This  being  the  case,  the  acceptability 
of  substitutes  for  money  depends  upon  the  certainty  of 
redemption  in  gold  on  demand,  and  the  greater  the  sur- 
plus of  gold  reserves  for  such  redemption  the  greater  will 
be  the  acceptability  of  the  substitute  currency  and,  ob- 
viously, the  less  the  demand  for  redemption.  Other  rea- 
sons for  the  accumulation  of  gold  in  the  vaults  of  the 
Federal  Reserve  banks,  connected  with  foreign  exchange, 
need  not  be  considered  here.  The  United  States  in  1922 
held  forty  per  cent  of  the  world's  monetary  gold  stock. 

Reserve  against  notes. — A  gold  reserve  of  40  per  cent 
must  be  held  against  the  reserve  notes  issued  through  a 
Federal  Reserve  bank.  Since  an  inflexible  rule  against 
depletion  of  the  reserve  below  this  amount  would  com- 
pel, in  effect,  an  additional  reserve  to  be  held  as  a  "re- 
serve against  reserves,"  it  is  provided  that  the  Federal 
Reserve  Board  may  suspend  any  reserve  requirement  of 
the  Act  for  a  period  not  exceeding  thirty  days,  and  re- 
new from  time  to  time  such  suspension  for  periods  not 
exceeding  fifteen  days,  provided,  however,  that  a  grad- 


642  PRINCIPLES  OF  BUSINESS 

uated  tax  shall  be  imposed  upon  any  deficiency  of  re- 
serves.^ 

This  graduated  tax  practically  inhibits  any  serious  re- 
duction of  reserves  and  operates  to  restore  depleted  re- 
serves, in  that  while  the  tax  is  paid  directly  by  the 
bank  in  which  the  deficiency  has  occurred,  the  bank  must 
add  the  amount  of  the  tax  to  the  rates  of  interest  and  dis- 
count fixed  by  the  Federal  Reserve  Board.  The  increase 
in  rates  reduces  the  demand  for  notes,  and  so  tends  auto- 
matically to  restore  the  reserves. 

Discount,  rediscount  and  purchase  of  commercial 
paper. — In  the  foregoing  sections  we  have  seen  how  the 
reserve  banks  may  issue  Federal  Reserve  notes  against 
approved  commercial  paper,  thus  adjusting  the  amount 
of  currency  in  circulation  to  the  current  needs  of  busi- 
ness. We  must  now  consider  briefly  the  several  forms 
and  classes  of  commercial  paper  in  which  member  banks 
and  reserve  banks  are  permitted  to  deal.  The  explana- 
tion which  follows  will  not  be  difficult  to  understand  if 
we  bear  in  mind  the  distinction  between  the  several  terms 
employed — loans  ;  discounts  ;  rediscounts  ;  and  purchases. 

Loans. ^  A  loan,  for  our  present  purpose,  is  an  advance 
of  funds  made  by  a  bank  to  a  customer  on  a  promissory 

1  Until  the  reserve  falls  below  32.5  per  cent,  the  tax  upon  the  de- 
ficiency is  at  the  rate  of  only  i  per  cent  per  annum,  but  below  this 
point  the  tax  is  increased  to  a  rate  "increasingly  of  not  less  than 
one  and  one-half  per  centum  per  annum  upon  each  two  and  one- 
half  per  centum  per  annum  that  such  reserve  falls  below  thirty-two 
and  one-half  per  centum  per  annum." 

-  Loans  may  also  be  made  by  reserve  banks  to  member  Ininks,  for 
periods  not  to  exceed  fifteen  days,  against  collateral  put  up  by  the 
member  bank.  Renewal  of  fifteen-day  loans  is  not  prohibited.  Be- 
sides commercial  paper,  the  collateral  on  such  loans  may  be  cus- 
tomers' notes,  of  not  over  90  days,  secured  by  United  States  bonds 
or  certificates  of  indebtedness. 


BANKING  643 

note,  secured  or  unsecured — a  typical  form  being  the  cus- 
tomer's unsecured,  "single-name"  note. 

Discounts  :  A  purchase  by  a  bank  of  its  customer's  "re- 
ceivables" indorsed  by  the  customer,  and  on  which  the 
customer  remains  liable.  Interest  is  deducted  in  ad- 
vance. The  customer's  own  note  is  also  "discounted"'  by 
the  bank. 

Rediscounts :  Purchases  by  a  reserve  bank  of  a  mem- 
ber bank's  "receivables,"  indorsed  by  the  member  bank, 
and  on  which,  of  course,  the  member  bank  remains  liable. 

Purchase :  The  buying  outright  of  the  paper  of  "out- 
siders," with  or  without  the  indorsement  of  a  member 
bank.  Purchase  is  of  interest  principally  in  connection 
with  "open-market"  operations  of  reserve  banks,  de- 
scribed hereinafter. 

The  operations  by  which  additional  currency  is  put  into 
circulation  are  those  ( i )  in  which  the  reserve  banks  re- 
discount paper  for  member  banks;  (2)  in  which  reserve 
banks  purchase  paper  in  open-market  operations.  Upon 
the  liquidation  of  the  paper,  the  currency  issued  against 
it  is  automatically  retired  from  circulation. 

Paper  eligible  for  rediscount  or  purchase, — "Eli- 
gible" paper  is  that  which  the  Federal  Reserve  banks  are 
permitted  to  rediscount  or  purchase.  The  requirements  of 
eligibility  are  not  quite  the  same  in  these  respective  opera- 
tions. Notes,  drafts  and  bills  of  exchange  are  eligible  for 
rediscount,  but  notes  are  not  eligible  for  purchase  in  open- 
market  operations.  "Demand"  paper  in  no  case  is  eli- 
gible, as  it  has  no  fixed  date  of  maturity.  "On  or  before" 
paper  may  be  eligible,  but  is  looked  upon  with  disfavor. 
In  general,  no  paper  is  eligible  unless  it  has  grown  out 


644  PRINCIPLES  OF  BUSINESS 

of  bona  fide  commercial  transactions,  as  distinguished 
from  paper  drawn  for  purposes  of  investment  or  specula- 
tion, with  the  exception  that  paper  drawn  for  the  purpose 
of  purchasing  or  carrying  United  States  bonds  or  notes 
is  eligible,  if  conforming  otherwise  to  the  requirements. 
No  paper  with  a  maturity  of  more  than  90  days,  exclu- 
sive of  days  of  grace,  is  "eligible,"  except  "six  months' 
agricultural  paper,"  in  the  form  of  promissory  notes  or 
trade  acceptances,  described  hereinafter. 

REDISCOUNTS 

Paper  eligible  for  rediscount. — A  note,  draft  or  bill 
of  exchange  to  be  eligible  for  rediscount : 

(a)  Must  be  one  the  proceeds  of  which  have  been  used 
or  are  to  be  used  in  producing,  purchasing,  carrying  or 
marketing  of  goods^  in  one  or  more  steps  of  the  process 
of  production,  manufacture  or  distribution. 

(b)  Must  not  be  one  the  proceeds  of  which  have  been 
used  or  are  to  be  used  for  permanent  or  fixed  investments 
of  any  kind,  such  as  land,  buildings,  or  machinery. 

(c)  Must  not  be  one  the  proceeds  of  which  have  been 
used  or  are  to  be  used  for  investments  of  a  purely  specu- 
lative character. 

(d)  May  be  secured  by  the  pledge  of  goods  or  col- 
lateral, provided  it  is  otherwise  eligible. 

The  various  "eligible"  notes,  drafts  or  bills  of  exchange 
may  be  grouped  under  the  following  heads : 

1.  Promissory  notes 

2.  Trade  acceptances 

3.  Agricultural  paper 

1  The  word  "goods,"  as  used  in  this  connection,  is  construed  to 
include  goods,  wares,  merchandise,  or  agricultural  products,  includ- 
inar  live  stock. 


BANKING  645 

4.  Commodity  paper 

5.  Bankers'  domestic  acceptances 

6.  Bankers'  foreign  acceptances 

7.  Bankers'  foreign  acceptances  drawn  for  the  purpose 
of  furnishing  dollar  exchange/ 

It  must  be  noted  here  that  while  it  is  true  in  general 
that  a  draft  accepted  by  a  member  bank  may  be  redis- 
counted  at  a  reserve  bank,  a  member  bank  may  accept 
certain  drafts  having  six  months'  sight  to  run  but  may 
not  rediscount  them  until  such  a  period  has  elapsed  as 
will  bring  them  within  a  maturity  of  90  days,  exclusive 
of  days  of  grace,  which  is  generally  a  condition  of  eligi- 
bility for  rediscount.  For  the  sake  of  brevity,  the  phrase 
"exclusive  of  days  of  grace"  may  here  be  taken  for 
granted  whenever  the  date  of  maturity  hereinafter  is 
mentioned. 

Promissory  notes — A  promissory  note,  to  be  eligible 
for  rediscount,  must  be  "an  unconditional  promise,  in 
writing,  signed  by  the  maker,  to  pay,  in  the  United  States, 
at  a  fixed  or  determinable  future  time,  a  sum  certain  in 
dollars  to  order  or  to  bearer,"  and  must  be  of  a  maturity, 
at  the  time  of  rediscount,  of  not  more  than  90  days,  ex- 
cept that  agricultural  or  live  stock  paper  whether  in  the 
form  of  promissory  notes  or  acceptances,  may  have  a 
maturity  not  exceeding  six  months. 

The  proceeds  of  a  promissory  note,  if  it  is  to  be  "eli- 
gible," must  be  used  for  commercial  purposes.  However, 
since  it  is  difficult  to  trace  the  proceeds  of  a  promissory 
note  to  their  actual  application  to  commercial  purposes,  it 
is  assumed  that  the  proceeds  are  used  for  commercial 
purposes  if  the  borrower  is  engaged  in  a  commercial  pur- 

^  See  page  f)8o. 


646  PRINCIPLES  OF  BUSINESS 

suit,  and  if  he  has  a  reasonable  excess  of  liquid  assets 
over  current  liabilities.  The  assumption  is,  that  under 
such  circumstances  an  amount  equivalent  to  that  of  the 
loan  will  be  taken  out  of  the  borrower's  liquid  assets  and 
applied  to  commercial  purposes,  whatever  disposal  may 
be  made  of  the  actual  or  immediate  proceeds  of  his 
note.  The  Federal  Reserve  bank  must  be  satisfied  of  the 
responsibility  of  the  borrower,  as  well  as  of  the  purposes 
for  which  the  proceeds  of  the  note  are  intended,  and  may 
require  a  financial  statement,  but  it  is  authorized  to  waive 
the  requirement  of  a  statement  in  the  following  circum- 
stances: if  the  note  is  secured  by  a  warehouse  or  similar 
receipt;  or  if  the  aggregate  of  the  obligations  of  the 
borrower  rediscounted  and  offered  for  rediscount  at  the 
reserve  bank  is  less  than  a  sum  equal  to  10  per  cent  of 
the  paid-in  capital  of  the  member  bank  and  does  not  ex- 
ceed $5,000. 

By  statute  it  is  provided  that  "The  aggregate  of  notes, 
drafts,  and  bills  bearing  the  signature  or  indorsement  of 
any  one  borrower,  whether  a  person,  company,  firm  or 
corporation  rediscounted  for  any  one  member  bank  shall 
at  no  time  exceed  10  per  cent  of  the  unimpaired  capital 
and  surplus  of  such  bank;  but  this  restriction  shall  not 
apply  to  the  discount  of  bills  of  exchange  drawn  in  good 
faith  against  actually  existing  values."  Promissory 
notes,  accordingly,  come  within  this  restriction,  without 
exception. 

Trade  acceptances. — A  draft  or  bill  of  exchange,  as 
defined  by  the  Federal  Reserve  Board,  for  the  purpose  of 
rediscounts,  is  "an  unconditional  order  in  writing,  ad- 
dressed by  one  person  to  another,  other  than  a  banker  as 


BANKING  647 

defined  under  B  (b)\  signed  by  the  person  giving  it,  re- 
quiring the  person  to  whom  it  is  addressed,  to  pay,  in  the 
United  States,  at  a  fixed  or  determinable  future  time,  a 
sum  certain  in  dollars  to  the  order  of  a  specified  person; 
and  a  trade  acceptance  is  defined  as  a  draft  or  bill  of  ex- 
change drawn  by  the  seller  of  goods  on  the  purchase  of 
goods  sold  and  accepted  by  such  purchaser."  The  "10 
per  cent  limit"  mentioned  above  does  not  apply  to  accept- 
ances, which  are  construed  not  to  be  loans  of  the  kind 
which  it  is  intended  to  restrict.  While  there  is  a  limit 
upon  the  amount  of  bank  acceptances  which  may  be  re- 
discounted,  as  we  shall  see  later,  there  is  practically  no 
limit  to  the  amount  of  trade  acceptances  which  may  be 
rediscounted,  even  for  the  same  bank  and  the  same 
drawer.  The  justification  for  this  provision  is  that  trade 
acceptances  are  "drawn  against  existing  values" — they 
are  secured  by  goods  which  have  been  or  shortly  are  to 
be  sold. 

A  Federal  Reserve  bank  is  required  "to  take  such  steps 
as  it  deems  necessary  to  satisfy  itself  as  to  the  eligibility 
of  the  draft  or  bill  offered  for  rediscount,  unless  it  pre- 
sents prima  facie  evidence  thereof  or  bears  a  stamp  or 
certificate  affixed  by  the  acceptor  or  drawer  showing  that 
it  is  a  trade  acceptance."  The  standard  form  of  trade 
acceptance  recommended  by  the  American  Trade  Accept- 
ance Council  bears  on  its  face  the  word  "accepted;"  with 

1  Federal  Reserve  Board  Regulation  A,  Series  of  1917.  The  Federal 
Reserve  Board  interprets  the  Act  and  issues  rulings  and  regulations 
from  time  to  time,  which  rulings  and  regulations  govern  the  policies 
and  practices  of  reserve  and  member  banks.  The  policy  of  the 
Board  in  its  interpretations  generally  is  to  lay  down  as  few  in- 
flexible rules  as  possible,  but  to  leave  the  bank  itself,  within 
certain  limits,  as  free  as  possible  to  solve  its  own  peculiar  problems, 


648 


PRINCIPLES  OF  BUSINESS 


spaces  for  insertion  of  date  of  acceptance,  place  of  pay- 
ment, and  signature  of  acceptor;  and  bears  also  the  fol- 
lowing statement,  which  identifies  the  bill  as  being  a  trade 
acceptance :  "The  obligation  of  the  acceptor  hereof  arises 
out  of  the  purchase  of  goods  from  the  drawer.  The 
acceptor  may  make  this  acceptance  payable  at  any  bank, 
banker  or  trust  company  in  the  United  States  which  he 
may  designate." 


/^2^t^  By?y/  i 


>E  ACCEPTANCE 

_after  e-^^^,-^^ — pay  to  the  order  of  OURSELVES 


%2Shc>.  -.. 


=-  Dollars 


Trade  Acceptance 

To  be  eligible  for  rediscount,  a  trade  acceptance  must 
be  indorsed  by  a  member  bank  and  must  have  a  maturity 
at  the  time  of  rediscount  of  not  more  than  90  days,  un- 
less it  is  "agricultural  paper,"  in  which  case  it  must  have 
a  maturity  not  exceeding  six  months. 

A  trade  acceptance  may  arise  from  either  domestic  or 
foreign  commercial  transactions,  but  must  in  all  cases  be 
payable  in  dollars  in  the  United  States. 

A  very  practical  reason  for  the  adoption  of  the  trade 
acceptance,  from  the  point  of  view  of  the  business  man, 
is  that  it  is  classed  as  prime  commercial  paper  and  ad- 


BANKING  649 

mitted  to  rediscount  at  a  preferential  rate,  about  one-half 
of  one  per  cent  lower,  as  a  rule,  than  that  fixed  for  promis- 
sory notes. 

From  the  point  of  view  of  the  banker,  acceptances  are 
desirable,  since  they  are  the  most  liquid  form  of  com- 
mercial paper  and  are  an  excellent  investment  for  second- 
ary reserves. 

The  great  mission  of  the  trade  acceptance  is  to  displace 
the  open  book-account.  The  principal  opposition  to  its 
introduction  has  come,  perhaps,  from  merchants  who 
have  been  in  the  habit  of  selling  goods  to  retailers  on  an 
open  book-account,  and  charging  higher  than  cash  prices 
to  those  w'ho  have  been  unable  to  purchase  on  cash  terms. 
This,  in  the  judgment  of  those  who  have  been  accustomed 
so  to  do,  constitutes  a  sort  of  "bankers'  profit''  for  the 
wholesaler,  who  is  reluctant  to  give  up  what  he  regards 
as  a  prerogative.  Retailers  also,  who  have  been  able  to 
avail  themselves  of  cash  discounts,  have  feared  that  the 
introduction  of  the  trade  acceptance  would  take  away  the 
advantage  they  had  formerly  possessed  over  their  weaker 
competitors  who,  by  reason  of  their  inability  to  take 
advantage  of  discounts  for  cash  payment,  have  been 
forced  to  pay  the  equivalent  of  interest  at  the  rate  of  as 
much  as  60  per  cent  per  annum  on  the  value  of  goods  pur- 
chased on  the  open  book-account.  Fair-minded  people, 
of  course,  can  have  no  sympathy  with  those  who  would 
withhold  from  business  a  means  of  cheapening  and  facili- 
tating commercial  transactions  merely  for  the  sake  of  a 
selfish  advantage. 

Opposition  has  come  also  from  shippers  who  have  hon- 
estly feared  that  their  own  credit  would  be  impaired  by 


650  PRINCIPLES  OF  BUSINESS 

the  creation  of  a  very  much  larger  contingent  Hability 
than  that  which  they  had  been  accustomed  to  carry  under 
the  book-account  system;  for  the  shipper,  of  course,  is 
liable,  along  with  the  buyer,  for  the  payment  of  the  accept- 
ance at  its  maturity.  This  objection  is  not  a  valid  one, 
for  the  shipper's  credit  is  strengthened,  everything  con- 
sidered. He  may  have  less  power  to  borrow  on  his  per- 
sonal note — this  cannot  be  denied — but  at  the  same  time 
he  has  less  need  to  borrow.  He  is  supposed  to  exercise 
due  caution  in  making  sales,  and  the  risk  of  default  on 
the  part  of  the  buyer  is  real  or  negligible  according  to 
the  care  which  the  shipper  himself  has  exercised.  The 
use  of  the  acceptance  makes  more  vivid  the  need  fo^ 
greater  care  in  credit-extension,  but  lessens,  rather  than 
increases,  the  amount  of  risk.  Losses  from  bad  debts  are 
reduced;  over-due  accounts  are  more  easily  collected, 
since  the  seller  has  the  acceptance  as  evidence  of  the  debt, 
as  well  as  the  definite  promise  of  the  debtor  to  pay  at  a 
certain  time;  again,  the  fact  that  the  goods  must  be  paid 
for  at  a  certain  time  causes  the  buyer  to  estimate  his 
needs  and  his  resources  more  carefully  and  to  refrain 
from  buying  injudiciously.  It  is  certain  that  in  view  of 
all  these  considerations  the  shipper  must  find  himself  in 
a  stronger  financial  condition  than  he  would  be  under  the 
book-account  system. 

The  real  reason,  of  course,  why  the  acceptance  has 
not  yet  come  into  general  use  in  the  United  States  is  that 
it  is  new.  The  average  business  man  always  prefers  to 
let  some  one  else  make  his  experiments.  The  educational 
campaign  conducted  by  the  Federal  Reserve  banks,  by 
alert  bankers  and  business  men  everywhere,  and  especially 


BANKING  651 

by  the  American  Trade  Acceptance  Council,  composed  of 
representatives  of  the  National  Association  of  Credit 
Men,  the  Chamber  of  Commerce  of  the  United  States,  the 
American  Bankers  Association,  and  the  National  Associa- 
tion of  Manufacturers,  must  result  in  a  steady  increase  in 
the  knowledge  and  use  of  the  trade  acceptance  until  it 
becomes  a  standard  instrument  in  commercial  transac- 
tions, as  familiar  and  as  indispensable  as  the  check. 

Six  months'  agricultural  paper.— Six  months'  agri- 
cultural paper,  as  defined  by  the  Federal  Reserve  Board 
for  purposes  of  rediscount,  is  "a  note,  draft,  bill  of  ex- 
change, or  trade  acceptance  drawn  or  issued  for  agri- 
cultural purposes,  or  based  on  live  stock;  that  is,  a  note, 
draft,  bill  of  exchange,  or  trade  acceptance  the  proceeds 
of  which  have  been  used,  or  are  to  be  used,  for  agricul- 
tural purposes,  including  the  breeding,  raising,  fattening, 
or  marketing  of  live  stock  and  which  has  a  maturity  at 
the  time  of  discount  of  not  more  than  six  months,  exclu- 
sive of  days  of  grace." 

To  be  eligible  for  rediscount  six  months'  agricultural 
paper  must  comply  with  the  regulations  which  would 
apply  to  it  if  its  maturity  were  90  days  or  less. 

Commodity  paper. — Commodity  paper  must  be  of  a 
maturity  of  not  more  than  90  days,  and  is  defined  as  '"a 
note,  draft,  bill  of  exchange,  or  trade  acceptance  accom-' 
panied  and  secured  by  shipping  documents  or  by  a  ware- 
house, terminal,  or  other  similar  receipt  covering  ap- 
proved and  readily  marketable,  non-perishable  staples 
properly  insured.'' 

Commodity  paper,  to  be  eligible  for  rediscount,  must 
conform  to  the  requirements  laid  down  by  the  Federal 


652  PRINCIPLES  OF  BUSINESS 

Reserve  Board  with  respect  to  shipping  documents,  re- 
ceipts, insurance  and  the  Hke,  and  must  be  paper  on  which 
the  rate  of  interest  or  discount,  including  commission, 
charged  the  maker,  does  not  exceed  6  per  cent  per  annum. 

The  special  rate  on  commodity  paper  is  intended  to 
assist  actual  producers  during  crop-moving  periods,  and 
the  Board  reserves  the  right  to  suspend  the  rates  when- 
ever it  is  apparent  that  the  movement  of  crops,  which  it 
is  intended  to  facilitate,  has  been  practically  completed. 

Banker's  acceptance,  defined. — A  banker's  accept- 
ance is  defined  by  the  Federal  Reserve  Board  as  "a,  draft 
or  bill  of  exchange  of  which  the  acceptor  is  a  bank  or 
trust  company,  or  a  firm,  person,  company,  or  corpora- 
tion engaged  in  the  business  of  granting  acceptance 
credits."  It  will  be  noted  that  to  constitute  the  acceptance 
a  banker's  acceptance,  only  the  acceptor  need  be  a  bank 
or  firm  engaged  in  the  business  of  granting  acceptance 
credits  except  in  the  case  of  bankers'  acceptances  drawn 
for  the  purpose  of  furnishing  dollar  exchange,  in  which 
case  the  drawer  as  well  as  the  acceptor  must  be  a  bank 
or  banker — the  acceptor,  moreover,  being  required  to  be 
a  member  bank. 

To  be  eligible  for  rediscount  the  bill  must  have  been 
drawn  under  a  credit  opened  for  the  purpose  of  conduct- 
•ing,  or  settling  accounts  resulting  from,  a  transaction  in- 
volving the  domestic  or  foreign  shipment  of  goods,  sub- 
ject to  the  restrictions  or  limitations  imposed  by  the  Act 
or  by  regulations  of  the  Federal  Reserve  Board  covering 
such  acceptances,  the  more  important  of  which  restric- 
tions or  limitations  will  be  noted  briefly  in  the  pages  that 
follow. 


BANKING  653 

Besides  rediscounting  bankers'  domestic  or  foreign 
acceptances,  any  Federal  Reserve  bank,  subject  to  the 
approval  of  the  Federal  Reserve  Board,  may  acquire 
drafts  or  bills  drawn  by  banks  or  bankers  abroad 
and  payable  in  the  United  States  for  the  purpose 
of  furnishing  dollar  exchange.  The  three  classes  of 
bankers'  acceptances  or  bills  herein  referred  to  are  de- 
scribed briefly  in  the  following  sections. 

Bankers'  domestic  acceptances.— Bankers'  domestic 
acceptances,  the  manner  of  using  which  is  touched  upon 
in  the  chapter  on  "Credit,"  are  invariably  secured  by  ship- 
ping documents  or  warehouse  or  similar  receipts.  Mem- 
ber banks  are  permitted  to  accept  domestic  bills  of  not 
more  than  six  months'  sight,  but  to  be  eligible  for  re- 
discount these  bills  must  be  of  not  more  than  90  days' 
maturity  at  the  time  of  rediscount,  and  must  be  indorsed 
by  at  least  one  member  bank.  The  acceptance  may  grow 
out  of  a  domestic  shipment  of  goods,  or  the  storage  of 
goods,  but  as  noted  above,  the  domestic  bill  is  invariably 
secured  by  shipping  documents  attached  at  the  time  of 
acceptance,  or  secured  by  warehouse  receipts  or  other 
such  documents  conveying  or  securing  title  covering 
readily  marketable  staples.  If  it  should  be  necessary  to 
release  the  documents  carrying  title  to  the  goods,  other 
collateral  must  be  substituted. 

Such  acceptances  do  not  come  under  the  "10  per  cent 
limit'' — that  upon  loans  which  a  member  bank  may  make 
to  a  single  borrower,  which  loans  may  not  in  any  given 
case  exceed  10  per  cent  of  the  bank's  capital  and  surplus — 
but  in  no  event  is  a  member  bank  permitted  to  make 
acceptances  of  domestic  bills  to  an  amount  exceeding  50 


654  PRINCIPLES  OF  BUSINESS 

per  cent  of  its  unimpaired  and  paid-in  capital  and  surplus. 
The  aggregate  of  its  domestic  and  foreign  acceptances, 
however  (exclusive  of  acceptances  drawn  by  foreign 
banks  or  bankers  for  the  purpose  of  furnishing  dollar 
exchange),  may  be  to  the  extent  of  lOO  per  cent  of  its 
paid-in  capital  and  surplus,  but  only  under  a  special  per- 
mit granted  by  the  Federal  Reserve  Board  to  such  mem- 
ber banks  as  make  application  for  such  permit  and  show 
that  the  business  and  banking  conditions  prevailing  in 
their  districts  justify  them  in  seeking  the  privilege.  Such 
a  permit  may  be  granted  only  to  banks  that  have  an  un- 
impaired surplus  of  at  least  20  per  cent  of  their  paid-in 
capital,  and  the  permit  may  be  revoked  by  the  Board  upon 
90  days'  notice  to  the  member  bank. 

Bankers'  foreign  acceptances/ — A  banker's  foreign 
acceptance  is  a  banker's  acceptance  growing  out  of  the 
importation  or  exportation  of  goods.  To  be  eligible  for 
rediscount,  it  must  have  a  maturity  of  not  more  than  90 
days,  and  must  be  indorsed  by  at  least  one  member  bank. 
The  limit  to  the  amount  of  foreign  bills  which  a  member 
bank  may  accept  is  50  per  cent  of  its  paid-in  capital  and 
surplus,  except  w'hen  a  "100  per  cent  permit"  is  secured 
from  the  Federal  Reserve  Board,  as  explained  in  the  pre- 
ceding section,  in  which  event  it  may  accept  an  aggregate 
of  domestic  and  foreign  bills  up  to  100  per  cent,  of  which, 
however,  not  more  than  50  per  cent  may  be  domestic  bills. 

This  limitation,  as  explained  above,  is  entirely  distinct 
from  and  not  affected  by  the  limitation  noted  in  the  fol- 

^  Changes  are  made  from  time  to  time  in  the  law  and  regulations 
affecting  bankers'  acceptances.  Some  large  banks  issue  from  time  to 
time  booklets  covering  bank  acceptance  practice.  For  example,  see 
those  of  the  American  Exchange  National  Bank  of  New  York. 


BANKING  655 

lowing  section,  governing  the  amount  of  bills  that  may  be 
accepted  for  the  purpose  of  furnishing  dollar  exchange. 

Bankers'  foreign  acceptances  drawn  for  the  purpose 
of  furnishing  dollar  exchange. — Any  member  bank  may 
accept  and  any  reserve  bank  may  rediscount  "drafts  or 
bills  of  exchange  drawn  upon  it  having  not  more  than 
three  months"  sight  to  run,  exclusive  of  days  of  grace, 
drawn,  under  regulations  to  be  prescribed  by  the  Federal 
Reserve  Board,  by  banks  or  bankers  in  foreign  countries 
or  dependencies  or  insular  possessions  of  the  United 
States  for  the  purpose  of  furnishing  dollar  exchange  as 
required  by  the  usages  of  trade  in  the  respective  countries, 
dependencies,  or  insular  possessions. 

"No  member  bank  shall  accept  such  drafts  or  bills  of 
exchange  for  any  one  bank  to  an  amount  exceeding  in 
the  aggregate  10  per  centum  of  the  paid-up  and  unim- 
paired capital  and  surplus  of  the  accepting  bank  unless  the 
draft  or  bill  of  exchange  is  accompanied  by  documents 
conveying  or  securing  title  or  by  some  other  adequate 
security.  No  member  bank  shall  accept  such  drafts  or 
bills  in  an  amount  exceeding  at  any  time  in  the  aggregate 
one-half  of  its  paid-up  and  unimpaired  capital  and  sur- 
plus. This  50  per  cent  limit  is  separate  and  distinct  from 
and  not  included  in  the  limits  placed  upon  the  acceptance 
of  drafts  and  bills  of  exchange  as  described  under  section 
A  of  this  regulation"  ^  (explained  above). 

The  distinctions,  it  will  be  observed,  between  bankers' 
acceptances  of  the  class  here  referred  to  and  those  re- 
ferred to  in  the  preceding  section  are  in  (i)  that  in  the 
case  of  the  acceptances  here  referred  to,  the  drawer  of  the 

1  Federal  Reserve  Board  Regulation  A,  series  of  1917. 


656  PRINCIPLES  OF  BUSINESS 

bill  must  be  a  bank  or  banker,  and  the  acceptor  a  member 
bank  (which  must,  moreover,  have  applied  for  and  re- 
ceived the  necessary  authority  from  the  Federal  Reserve 
Board);  and  (2)  that  whereas  the  bankers'  acceptances 
referred  to  in  the  preceding  section  must  have  grown  out 
of  specific  transactions  involving  the  importation  or  ex- 
portation of  goods,  the  acceptances  of  the  class  covered 
by  the  present  section  are  not  necessarily  limited  to  those 
growing  out  of  specific  shipments  of  goods,  but  may  be 
drawn  for  the  transfer  of  funds  for  any  legitimate  pur- 
pose as  required  by  the  usages  of  trade  in  the  countries 
of  their  origin,  and  as  approved  by  the  Federal  Reserve 
Board.  This  provision  enables  member  banks  conven- 
iently to  maintain  their  required  balances  abroad  and 
foreign  banks  to  adjust  conveniently  their  balances  in  the 
United  States. 

OPEN-MARKET    PURCHASES 

Open-market  operations  authorized. — By  section  14 
of  the  Federal  Reserve  Act  it  is  provided  that  Federal 
Reserve  banks,  under  rules  and  regulations  to  be  pre- 
scribed by  the  Federal  Reserve  Board,  may  purchase  and 
sell  in  the  open  market  from  banks,  firms,  corporations, 
or  individuals,  cable  transfers,  bankers'  acceptances  and 
bills  of  exchange  of  the  kinds  and  maturities  made  eligible 
by  the  Act  for  rediscount,  with  or  without  the  indorse- 
ment of  a  member  bank.  Promissory  notes  are  not  eli- 
gible for  purchase  on  the  open  market. 

Besides  the  specified  forms  of  commercial  paper,  re- 
serve banks  are  permitted  to  purchase  and  sell  in  the  open 
market :    gold  coin  and  bullion ;  bonds  and  notes  of  the 


BANKING  657 

United  States ; and  certain  classes  of  municipal  obligations. 

In  order  that  such  transactions  in  foreign  markets 
could  be  carried  on  it  was  provided,  in  section  14  of  the 
Act,  that  accounts  should  be  opened  with  foreign  corre- 
spondent's and  agencies. 

Bills  of  exchange  and  trade  acceptances  in  open- 
market  operations. — To  be  eligible  for  purchase  the  bill 
must  have  arisen  out  of  an  actual  commercial  transaction, 
domestic  or  foreign,  and  must  have  a  maturity  at  the 
time  of  purchase  of  not  over  90  days,  exclusive  of  days 
of  grace.  Unless  indorsed  by  a  member  bank  a  bill  is 
not  eligible  for  purchase  until  a  satisfactory  statement  has 
been  furnished  of  the  financial  condition  of  one  or  more 
of  the  parties  thereto. 

Bankers'  acceptances  in  open-market  operations. — 
A  banker's  acceptance,  to  be  eligible  for  purchase  in  open- 
market  operations,  must  have  a  maturity  at  the  time  of 
purchase  of  not  over  90  days,  exclusive  of  days  of  grace, 
and  must  have  been  drawn  under  a  credit  opened  for  the 
purpose  of  conducting,  or  settling  accounts  resulting 
from,  a  transaction  or  transactions  involving: 

1.  Importation  or  exportation  of  goods; 

2.  Domestic  shipment  of  goods,  provided  that  shipping 
documents  accompany  the  bill  at  the  time  of  its  accept- 
ance; or 

3.  The  storage  within  the  United  States  of  readily 
marketable  goods,  provided  the  acceptor  of  the  bill  is  se- 
cured by  warehouse,  terminal  or  other  similar  receipt;  or 

4.  The  storage  within  the  United  States  of  goods 
which  have  been  actually  sold,  provided  the  acceptor  of 
the  bill  is  secured  by  the  pledge  of  such  goods ;  or 


658  PRINCIPLES  OF  BUSINESS 

5.  It  must  be  a  bill  drawn  by  a  bank  or  banker  in  a 
foreign  country  for  the  purpose  of  furnishing  dollar  ex- 
change. 

In  the  latter  case,  the  bank  or  banker  drawing  the  bill 
must  be  in  a  country,  dependency  or  possessioh  whose 
usages  of  trade  have  been  determined  by  the  Federal 
Reserve  Board  to  require  the  drawing  of  bills  of  this 
character. 

"The  Federal  Reserve  bank  before  purchasing  a 
banker's  acceptance,  must  be  satisfied,  by  reference  to  the 
acceptance  itself  or  otherwise,  that  it  is  eligible  for  pur- 
chase. Satisfactory  evidence  of  eligibility  may  consist 
of  a  stamp  or  certificate  afiixed  by  the  acceptor,  in  fonn 
satisfactory  to  the  reserve  bank.  No  evidence  of  eligibil- 
ity is  required  with  respect  to  a  bill  accepted  by  a  national 
bank." 

Bankers'  acceptances,  other  than  those  accepted  or  in- 
dorsed by  member  banks,  are  eligible  for  purchase  only 
after  the  acceptor  has  furnished  a  satisfactory  statement 
of  financial  condition  in  form  to  be  approved  by  the  Fed- 
eral Reserve  Board,  and  has  agreed  in  writing  with  a 
Federal  Reserve  bank  to  inform  it  on  request  concerning 
the  transactions  underlying  such  acceptances. 

The  purpose  of  the  section  of  the  Act  permitting  Fed- 
eral banks  may  exercise  a  beneficial  and  stablizing  influ- 
ence upon  the  market  for  commercial  paper  and  particu- 
larly that  they  may  have  a  m.eans  of  controlling  the  rates. 

In  defining  the  classes  of  commercial  paper  which  it 
makes  eligible  for  rediscount  and  then  fixing  the  rates  of 
interest  and  discount — forcing  the  rates  down,  if  neces- 
sary, by  purchases  of  commercial  paper  in  the  open  mar- 


BANKING  659 

ket,  the  Federal  Reserve  system  renders  business  in  gen- 
eral a  service  the  value  of  which  it  would  be  difficult  to 
estimate.  Not  only  is  a  direct  aid  thus  rendered  to  busi- 
ness, but  also  an  indirect  aid — in  the  promoting  of  better 
business  methods.  The  primary  function  of  the  system, 
of  course,  is  to  adjust  the  volume  of  exchangeable  credit 
to  the  amount  required  as  a  medium  of  exchange  for 
legitimate   commercial   transactions. 

The  Federal  Reserve  system,  as  will  have  been  ob- 
served, is  directly  concerned  solely  with  short-term  com- 
mercial credit.  There  still  remains,  it  would  seem,  some- 
thing to  be  devised  to  meet  the  need  for  long-term  indus- 
trial credit,  >vhich  need,  while  not  always  so  pressing,  is 
fully  as  legitimate  a  need  as  that  for  short-term  credit. 
Certainly,  the  adjustment  of  the  supply  of  short-term 
credit  tends  to  facilitate  also  the  transactions  which  in- 
volve long-term  credit,  since  capital  is  left  free  for  invest- 
ment purposes  which  would  otherwise  be  required  for  the 
financing  of  commercial  transactions,  but  undoubtedly, 
there  is  room  for  some  direct  assistance  to  business  in 
view  of  its  need  for  fixed  capital  as  well  as  for  temporary 
or  working  capital.  When  the  workings  of  the  present 
system  have  been  more  adequately  observed,  it  is  pos- 
sible that  a  long-term  credit  system  may  be  devised. 

BIBLIOGRAPHY 

Holdsworth,  J.  T.,  Money  and  Banking. 

Johnson,  J.  F.,  Money  and  Currency. 

Conant,  C.  A.,  The  Principles  of  Money  and  Banking. 

Kniffin,  W.  H.,  Jr.,  The  Practical  Work  of  a  Bank. 

Moulton,  H.  G..  Money  and  Banking. 

Phillips,  C.  A.,  Readings  in  Money  and  Banking. 

Scott,  W.  A.,  Money  and  Banking. 

Dunbar,  C.  F.,  Theory  and  History  of  Banking. 

Fisher,  Irving,  The  Purchasing  Power  of  Money. 


CHAPTER  XXVIII 

EXCHANGE 

The  meaning  of  "exchange." — Wherever  there  is  a 
traffic  in  goods,  there  is  a  corresponding  traffic  in  money 
or  credit  with  which  the  goods  are  paid  for.  The  currents 
of  payment  flow  in  a  direction  opposite  to  that  of  the 
movement  of  the  goods.  Somewhat  as  raihoad  and 
steamship  Hnes  form  a  system  for  transporting  the  goods, 
the  banks  that  deal  in  exchange  form  a  system  for  trans- 
porting credit.^  This  bank  credit,  convertible  into  the 
monetary  units  current  at  the  place  of  payment,  is  known 
as  "exchange." 

"Exchange,"  in  a  slightly  different  sense,  means  also  the 
process  of  paying  money  in  a  distant  place,  through  the 
transfer  of  bank  credit  convertible  into  money  at  the  place 
of  payment.  Domestic  exchange  is  that  used  for  trans- 
ferring funds  within  a  single  country;  foreign  exchange 
for  the  transfer  of  funds  from  one  country  to  another 
country. 

The  need  for  exchange. — The  transactions  which 
make  necessary  the  transfer  of  funds,  giving  rise  to  the 
use  of  domestic  and  foreign  exchange,  may  be  summar- 
ized as  follows : 

1.  The  buying  and  selling  of  merchandise. 

2.  The  buying  and  selling  of  securities,  such  as  stocks 

and  bonds;  also,  the  payment  of  dividends  and  interest  to 

the  holders  of  the  securities. 

^For  an  explanation  of  credit  see  the  chapter  on  "Banking." 

660 


EXCHANGE  661 

3.  The  making  and  subsequent  repayment  of  long-term 
and  short-term  loans;  also,  the  payment  of  interest  on 
the  loans. 

4.  The  purchase  and  operation  of  business  enterprises 
at  a  distance  or  abroad. 

5.  Minor  transactions,  among  which  may  b'e  men- 
tioned :  use  of  traveler's  letters  of  credit ;  payments  for 
legal  and  other  services  rendered;  remittances  made  by 
immigrants. 

The  theory  of  exchange. — As  between  the  individuals 
who  settle  their  accounts  by  payment  in  exchange,  each 
transaction  is  complete  in  itself.  The  process  of  making 
payment  in  exchange,  and  the  various  types  of  "bills  of 
exchange,"  will  be  explained  later  in  this  chapter.  It  is 
sufficient  here  to  say  that  the  typical  transaction  is  one 
in  which  goods  are  purchased  and  paid  for  by  the  deposit 
of  funds  in  the  buyer's  bank  and  the  transfer  of  the  funds 
to  the  seller's  credit  in  his  own  bank. 

As  between  the  banks  which  act  as  intermediaries  in 
the  settlement  of  accounts  between  buyers  and  sellers, 
however,  debits  and  credits  tend  to  cancel,  and  the  only 
money  that  is  used  is  for  settlement  of  the  balance,  or 
difference. 

As  between  countries,  likewise,  or  between  sections  of 
the  same  country,  exports  pay  for  imports,  and  the  only 
actual  money  that  changes  hands  is  the  amount  of  the 
difference  in  value  between  imports  and  exports. 

Exchange,  therefore,  so  far  as  the  transfer  of  funds 
between  communities  is  concerned,  is  little  more  than  a 
rather  elaborate  system  of  bookkeeping. 

The  "system  of  exchange." — As  noted  above,   the 


662  PRINCIPLES  OF  BUSINESS 

banks  which  deal  in  exchange  form  a  "system"  for  the 
transfer  of  credit.  The  transactions  which  give  rise  to 
the  need  for  payment  in  exchange  involve  buyers  and 
sellers,  with  their  local  banks,  in  all  parts  of  the  country, 
and  in  all  quarters  of  the  globe.  Obviously,  it  would 
be  impossible  for  each  bank  in  the  country,  or  in  the 
world,  to  keep  funds  on  deposit  in  every  other  bank,  in 
order  that  drafts  might  be  issued  against  such  deposits 
when  required.  It  is  possible,  however,  for  each  bank  of 
importance  to  keep  funds  on  deposit  with  banks  at  cen- 
tral points,  where  drafts  can  be  charged  to  one  bank's 
account  and  credited  to  that  of  another,  somewhat  as  at 
a  local  clearing  house. 

The  process  of  exchange. — There  are  two  methods  by 
which  accounts  may  be  settled  by  the  use  of  exchange. 
The  debtor  may  purchase  a  bank  draft  and  send  it  to  the 
creditor,  or  the  creditor  may  draw  a  draft  upon  the 
debtor. 

If  the  debtor  takes  the  initiative,  the  process  is  as  fol- 
lows :  The  debtor  goes  to  his  bank  and  buys,  perhaps, 
a  New  York  draft  for  the  amount  he  owes.  This  draft 
is  an  order  from  the  local  bank  to  its  correspondent  bank 
in  New  York,  requesting  the  New  York  bank  to  pay  the 
sum  specified  to  the  person  named  as  pa)'ee,  or  to  his 
order.  The  debtor  then  sends  this  draft — known  as  New 
York  exchange — to  the  creditor,  who  "cashes"  it  or  de- 
posits it  for  credit  to  his  account,  just  as  he  would  "cash" 
or  deposit  a  check.  The  creditor's  bank  is  willing  to 
"cash"  the  draft,  because  it  is  the  obligation  of  a  bank, 
payable  at  a  central  point,  where  the  creditor's  bank  also 
Jkeeps  an  account.     This  bank  then  sends  the  draft  to  its 


EXCHANGE  663 

New  York  correspondent  for  collection  and  credit  to  its 
New  York  balance. 

If  the  creditor  "draws"  on  the  debtor,  the  process  is  as 
follows :  The  creditor  writes  an  order  requesting  the 
debtor  to  pay  to  the  order  of  the  creditor  or  his  agent  the 
£um  specified  and  to  charge  same  to  the  drawer's  account. 
Collection  of  such  a  draft  may  be  made  by  the  creditor 
through  a  chain  of  banks,  as  follows  :  ( i )  the  creditor's 
bank;  (2)  this  bank's  New  York  correspondent;  (3)  the 
New  York  correspondent  of  the  debtor's  bank;  and  (4) 
the  debtor's  bank. 

Domestic  bills  of  exchange. — The  two  classes  of 
drafts  used  in  domestic  exchange  are  commercial  drafts 
and  bank  drafts,  the  uses  of  which  are  described  briefly 
in  the  chapters  on  "Credit"  and  "Banking." 

Bank  drafts  are  drafts  drawn  by  the  cashier  of  a  bank 
upon  another  bank  at  which  the  first  bank  has  established 
a  credit — that  is,  in  which  it  has  funds  on  deposit.  The 
typical  bank  draft  is  a  draft  upon  a  New  York  bank,  and 
is  called  "New  York  exchange."  (It  is  understood,  of 
course,  that  the  draft  itself  is  not  the  exchange,  but  that 
the  exchange  is  the  credit  evidenced  by  the  draft. )  New 
York  exchange,  among  banks,  is  credit  of  general  accept- 
ability, since  practically  all  important  banks  have  fre- 
quent need  of  New  York  exchange,  and  maintain  rela- 
tions v^ith  one  or  more  New  York  banks.  The  exchange 
facilities  afforded  by  the  Federal  Reserve  banks  will, 
naturally,  tend  more  and  more  to  lessen  the  relative  im- 
portance of  New  York  exchange,  the  reserve  bank  of 
each  district  becoming  an  intermediary  for  member  banks 
of  the  district  for  the  clearing  of  bills  of  exchange. 


664  PRINCIPLES  OF  BUSINESS 

Foreign  bills  of  exchange. — In  foreign  exchange  the 
instruments  by  which  credit  is  transferred  are  of  three 
general  kinds — commercial  bills  of  exchange,  bankers' 
bills  and  letters  of  credit.  As  to  time  of  payment,  these 
are  classed  as  short  bills  and  long  bills.  Short  bills  are 
those  which  have  not  over  30  days  to  run ;  long  bills  have 
more  than  30  days  to  run.  Short  bills  include  bills  pay- 
able at  sight  or  on  demand. 


m, ^....^ 


Foreign  Bill  of  Exchange 

A  bill  payable  at  or  after  sight  has  no  date  of  maturity 
until  it  has  been  presented  to  the  drawer. 

Commercial  bills  are  classed,  in  the  first  place,  as 
"clean"  or  "documentary." 

A  commercial  "clean  bill"  has  no  shipping  papers  of 
other  documents  attached,  and  may  be  either  short  or 
long,  but  is  usually  drawn  at  60  or  90  days.  It  has  no 
maturity  until  accepted.  Until  accepted,  a  clean  bill  is 
"one-name  paper;"  after  acceptance  it  is  "two-name 
paper."  It  has  no  security  except  the  credit  of  the  drawer 
and,  after  acceptance,  of  the  drawee. 


EXCHANGE  665 

A  commercial  "documentary  bill"  is  always  secured  by 
the  papers  which  carry  the  title  to  the  merchandise  the 
sale  of  which  the  bill  represents.  The  bill  of  lading,  in- 
voice, or  other  papers  may  be  accompanied  by  an  "hy- 
pothecation certificate,"  specifically  pledging  the  goods 
covered  by  the  documents,  for  the  protection  of  the 
banker  who  discounts  the  bill.  The  hypothecation  cer- 
tificate may  be  an  individual  certificate,  covering  only  the 
one  shipment,  or  it  may  be  a  "blanket''  certificate,  cover- 
ing all  current  transactions  between  the  exporter  and  his 
banker.  There  will  also  be  an  "insurance  certificate,'' 
stating  the  amount  for  which  the  goods  are  insured,  and 
the  name  of  the  company  which  issued  the  insurance. 

Such  bills  are  usually  long  bills,  but  may  be  drawn  at 
sight,  or  may  run  anywhere  from  7  days  to  60  or  90  days' 
sight. 

Commercial  documentary  bills  are  classed  as  "accept- 
ance bills,"  in  which  case  the  documents  are  to  be  released 
to  the  consignee  upon  acceptance  of  the  bill ;  or  "payment 
bills,"  in  which  case  the  documents  are  not  to  be  re- 
leased until  the  bill  is  paid.  Commercial  documentary 
bills  are  usually  acceptance  bills.  The  fact  that  a  pay- 
ment bill  is  drawn  instead  of  an  acceptance  bill  is  not 
necessarily,  however,  a  reflection  upon  the  honor  or  credit 
of  the  drawee,  for  in  some  classes  of  dealings  the  pay- 
ment bill  is  the  customary  form. 

It  is  a  practice,  generally,  to  have  bills  sent  abroad  dis- 
counted immediately  upon  their  arrival  and  the  proceeds 
credited  to  the  account  of  the  drawer.  Since  the  discount 
markets  will  take  only  clean  bills  (those  without  docu- 
ments attached),  an  acceptance  bill  may  be  discounted  as, 


666  PRINCIPLES  OF  BUSINESS 

soon  as  accepted  by  the  consignee,  for  then  the  documents 
are  released.  A  payment  bill,  however,  cannot  be  dis- 
counted, as  the  documents  remain  with  the  bill  until  it  is 
paid,  and  the  bankers  who  discount  bills,  besides  being 
wary  of  a  bill  upon  which  security  seems  to  be  necessary, 
do  not  care  to  be  troubled  with  the  disposal  of  the  papers ; 
therefore,  they  refuse  to  receive  payment  bills  for  dis- 
count. 

A  payment  bill,  however,  may  be  more  profitable  than 
an  acceptance  bill,  because  it  is  likely  to  be  paid  at  once, 
as  the  drawee  usually  desires  to  get  possession  of  the 
goods  as  soon  as  possible.  The  time  when  a  payment  bill 
is  "taken  up  under  rebate"  is  the  important  factor,  of 
course.  If  the  bill  is  drawn  at  60  days  and  is  paid  upon 
presentation,  the  buyer  of  such  a  bill  gets  a  larger  return 
than  he  would  get  if  the  bill  had  been  discounted,  for  the 
rebate  rate  is  lower  than  the  discount  rate.  If.it  is  not 
paid  until  maturity,  however,  as  may  happen,  the  buyer 
of  the  bill  cannot  get  the  use  of  his  money  for  60  days, 
and  suffers  a  loss,  as  compared  with  what  he  would  have 
received  for  the  handling  of  an  acceptance,  or  discount- 
able bill. 

Bankers'  bills. — Bankers'  bills  are  of  two  classes — 
"short  bills''  and  "long  bills."  Most  of  the  short  bills  are 
"sight  bills,"  also  called  "demand  drafts"  or  "checks," 
drawn  by  bankers  against  their  balances  on  deposit  in 
banks  in  the  various  financial  centers  and  payable  on  pres- 
entation. When  haste  in  payment  is  required,  "cables" 
are  sent  instead  of  sight  bills,  a  "cable"  being  an  order' 
to  pay,  transmitted  by  cable. 

Long  bills  are  of  three  kinds,  and  are  usually  drawn  at 


EXCHANGE  667 

60  or  90  days'  sight.  The  three  classes  of  long  bills  are : 
( I )  bills  drawn  in  ordinary  business  operations,  as  when 
a  client  desires  to  pay  an  obligation  abroad — maturing  in 
perhaps  60  days — with  funds  he  has  on  hand,  and  so  buys 
a  time  draft,  which  costs  less  than  a  demand  draft;  (2) 
long  bills  arising  from  the  making  of  foreign  loans;  (3) 
finance  bills.  The  finance  bill  is  a  means  by  w^hich  the- 
banker  borrows  funds  from  foreign  centers  where  money- 
may  be  cheap  and  lends  them  at  home,  where  interest 
rates  may  be  higher.  He  "covers"  his  maturing  finance 
bill  by  remitting  sight  exchange,  which  he  purchases  in 
the  market  at  the  best  price  he  can. 

Letters  of  credit. — Letters  of  credit  are  of  two  classes 
— travelers'  letters  and  commercial  letters.  In  either 
case,  the  letter  of  credit  is  a  letter  authorizing  the  holder 
to  draw  upon  the  correspondents  of  the  issuing  bank  for 
the  amount  specified,  the  issuing  bank  engaging  to  reim- 
burse the  correspondent  upon  presentation  of  the  original 
draft. 

The  travelers'  letter  of  credit  is  issued  for  the  conven- 
ience of  tourists,  and  is  a  circular  letter  addressed  to  cor- 
respondents of  the  bank  at  various  points  on  the  tourist's 
route,  requesting  these  correspondents  to  honor  the  tour- 
ist's drafts  up  to  a  specified  amount. 

The  commercial  letter  of  credit  is  used  for  paying  ex- 
porters of  goods  in  foreign  countries,  and  authorizes  the 
holder  to  draw  upon  the  issuing  bank  for  the  amount  and 
under  the  conditions  specified  in  the  letter  of  credit.  The 
documents  conveying  title  to  the  goods  are  security  for 
the  protection  of  the  bank,  so  that  the  purchaser  of  the 
letter  of  credit  does  not  have  to  pay  for  the  goods  until 


668  PRINCIPLES  OF  BUSINESS 

their  arrival,  while  the  shipper  of  the  goods  is  able  to  get 
his  money  at  once,  upon  turning  over  to  his  bank  the  letter 
of  credit  with  the  bill  of  lading,  invoice  and  other  shipping 
papers.  This  bank  then  forwards  the  papers  to  the  issu- 
ing bank,  which  holds  them  pending  the  arrival  of  the 
goods  and  payment  therefor  by  the  consignee. 

Foreign  letters  of  credit,  like  other  instruments  of  for- 
eign exchange,  are  generally  drawn  in  pounds  sterling, 
which  is  the  world's  currency,  on  account  of  the  facilities 
of  London  for  making  payments  or  collections  in  any  part 
of  the  world. 

The  price  of  bills  of  exchange/ — The  rate  quoted  on 
foreign  exchange  is  fixed  by  the  price  of  "cables,"  which, 
of  course,  approximates  the  rate  actually  existing  at  any 
given  time.  The  theory  is,  that  when  a  debtor  purchases 
cable  exchange,  the  banker  transfers  his  foreign  credit 
immediately  to  the  payee,  and  does  not  enjoy  for  any 
appreciable  time  the  use  of  the  funds  which  he  receives 
from  the  purchaser  of  the  exchange.  The  cable  rate,  ac- 
cordingly, is  the  highest. 

If  a  sight  draft  is  sent,  the  banker  can  sell  it  at  a  lower 
price  than  a  cable,  for  he  has  the  use  of  the  funds  at  least 
while  the  bill  is  in  transit. 

Time  drafts  can  be  sold  at  a  lower  price  still,  for  the 
banker  will  not  have  to  pay  the  draft  abroad  for  60  or 
90  days. 

Various  factors,  of  course,  affect  the  price  of  exchange, 
but  the  fundamental  relationship  of  the  prices  of  cables, 
short  bills  and  long  bills  is  that  described  above. 

The  foregoing  applies  only  to  "prime"  bankers'  bills, 

^  See  Franklin  Escher,  Foreign  Exchange  Explained. 


EXCHANGE  669 

concerning  the  payment  of  which  when  due  there  is  not 
the  slightest  doubt.  In  practice,  the  price  of  commercial 
bills  varies  according  to  the  prestige  and  reputation  of  the 
drawer  and  of  the  drawee. 

The  price  of  exchange,  as  referred  to  in  the  foregoing, 
is  merely  the  relative  price  of  different  classes  of  bills. 
The  rate  or  price  of  exchange,  as  between  one  country  and 
another,  will  be  considered  in  the  following  section. 

The  rate  of  exchange. — The  intrinsic  relation  of  the 
monetary  unit  of  one  country  with  that  of  another  is  ex- 
pressed by  the  "par  of  exchange,"  which  never  varies — 
the  par  of  exchange  being,  for  practical  purposes,  the 
ratio  between  the  weights  of  the  precious  metal  (usually 
gold)  contained  in  the  standard  coins  of  the  respective 
countries.^  For  example,  the  par  of  exchange  between 
the  United  States  and  England  is  4.8665,  this  being  the 
amount  of  gold  in  the  pound  sterling  as  compared  with 
the  amount  of  gold  in  the  standard  U.  S.  dollar. 

The   "rate   of   exchange,"   however,   as   distinguished 

^  The  par  of  exchange  on  important  countries,  calculated  from 
the  United  States  Mint's  intrinsic  valuation  of  their  standard  coin 
in  terms  of  American  currency,  is  as  follows : 

Argentina 42.45  cents  to  the  paper  dollar 

Austria 20.3  cents  to  the  crown 

Canada $1.00  to  the  dollar 

Denmark 26.8  cents  to  the  krone 

England $4,865^  to  the  sovereign 

France 19.3  cents  to  the  franc 

Germany 23.82  cents  to  the  mark 

Holland 0.2  cents  to  ^le  florin 

India 48.66  cents  to  the  rupee 

Japan 49.8  cents  to  the  yen 

Russia. 51.2  cents  to  the  ruble 

Spain 19.3  cents  to  the  peseta 

Par  of  New  York  exchange  on  Italy  and  Switzerland  is  the  same 
as  that  on  France ;  the  franc,  lira,  and  peseta  are  all  valued  by  the 
Mint  at  19.3  cents.  Par  of  exchange  on  Norway  and  Sweden  is  the 
same  as  on  Denmark. 


^670  PRINCIPLES  OF  BUSINESS 

from  the  "par  of  exchange,"  is  the  rate  at  which  the 
monetary  units  of  one  country  actually  exchange  for 
those  of  another. 

If  it  cost  nothing  to  ship  gold  between  the  United 
States  and  England,  the  rate  of  exchange  on  London 
would  always  be  at  par.  Exchange  on  London,  or  "ster- 
ling exchange,"  during  the  war,  was  "pegged,"  or  fixed 
by  agreement,  at  a  point  slightly  below  par,  called  the 
"war  par."  The  agreement  referred  to — made  between 
the  United  States,  Great  Britain  and  France — was  for 
the  purpose  of  preventing  the  fluctuations  in  the  rate 
which  would  have  occurred  because  of  the  fact  that  it  was 
inexpedient  to  subject  gold  to  the  ocean  risk.  Normally, 
of  course,  the  transfer  of  gold  steadies  the  rates. 

Even  in  normal  times,  however,  there  is  a  cost  and  a 
risk  attached  to  the  shipment  of  gold,  so  that  the  rate  of 
exchange  may  vary  within  the  "gold  points,"  that  is 
within  the  limits  above  and  below  par  set  by  the  cost  and 
risk  of  shipping  gold  instead  of  making  payments  in  ex- 
change. 

The  rate,  or  price,  of  exchange,  in  normal  times,  is  de- 
termined, like  the  price  of  other  commodities,  by  supply 
and  demand,  the  extent  of  the  possible  fluctuation  being 
limited  by  the  fact  that  when  the  price  of  exchange  goes 
to  a  point  above  the  cost  of  making  payment  by  shipping 
gold,  gold  will  be  used  in  making  payment ;  the  supply  of 
exchange  will  be  proportionately  increased,  and  the  price 
will  fall.  This  is  conditioned,  of  course,  upon  the  ab- 
sence of  legal  restrictions  upon  the  "purchase"  and  ship- 
ment of  gold. 

The  supply  of  and  demand  for  exchange,  as  between 


EXCHANGE  671 

any  two  countries,  and  as  a  factor  in  the  rate  of  exchange 
between  these  two  countries,  does  not  depend  alone  upon 
their  trade  relations  with  each  other,  but  upon  the  ''bal- 
ance of  trade"  which  results  from  the  average  of  the 
accounts  of  one  country  with  all  the  countries  with  which 
it  trades.  This  may  be  illustrated  readily  by  using  for 
comparison  the  facts  which  determine  the  condition  of  the 
bank  account  of  an  individual.  A,  the  depositor,  may 
have  business  dealings  with  B,  C,  D  and  E.  Obviously, 
the  size  of  his  bank  balance,  and  consequently  the  state  of 
his  credit,  does  not  depend  upon  his  dealings  with  any  one 
of  the  group,  but  upon  his  debits  and  credits  with  respect 
to  all.  He  may  be  indebted  to  B;  but  C,  D  and  E  may 
each  owe  him  a  greater  amount,  so  that  the  balance  of 
credit  may  be  in  his  favor.  He  may  convert  the  credit 
^nto  a  bank  deposit,  or  into  money ;  and  his  supply  of  "ex- 
change" will  be  ample  for  payments  to  any  of  the  group. 
Obviously,  then,  as  between  countries  A,  B,  C,  D  and 
E,  if  A's  balance  of  trade  is  favorable,  with  respect  to 
the  group  as  a  whole,  the  fact  that  A  may  be  indebted  to 
B  does  not  mean  that  its  credit  in  B  is  impaired  and  re- 
garded as  worth  less  than  par.  A  may  have  an  abun- 
dance of  credit  in  C,  D  and  E,  which  may  be  transferred 
to  B  in  payment  of  A's  indebtedness.  Where  the  credit 
is  abundant,  its  price  falls;  and  if  the  price  of  A's  credit 
in  B,  where  the  credit  is  deficient,  tends  to  rise,  payment 
in  B  may  be  made  through  C,  D  or  E,  by  triangulation. 
By  this  means,  under  normal  conditions,  the  rate  of  ex- 
change as  between  one  country  and  all  other  countries 
tends  to  be  equalized,  regardless  of  individual  debits  and 
credits. 


672  PRINCIPLES  OF  BUSINESS 

Under  war  conditions,  of  course,  the  forces  which  or- 
dinarily determine  the  rates  of  exchange  between  coun- 
tries are  deranged  and  made  in  great  part  inoperative. 
Not  only  is  trade  diverted  from  its  usual  channels,  but 
also  the  movement  of  gold  which  ordinarily  stabilizes  the 
rates  is  checked.  The  United  States,  for  example,  laid 
an  embargo  on  the  export  of  gold.  Such  a  course,  no 
doubt,  is  expedient,  for  shipment  of  gold,  when  tonnage 
is  needed  for  other  purposes,  is  expensive,  and  the  sea- 
risk  undeniably  was  great. 

Each  country  desires  to  keep  in  its  possession  as  much 
■gold  as  possible,  with  a  view  to  providing  a  stable  basis 
for  the  issue  of  currency,  if  for  no  other  purpose.  So 
far  as  the  rates  of  exchange  are  concerned,  of  course,  the 
hoarding  of  gold  cannot  strengthen  them,  any  more  than 
an  individual  could  strengthen  his  own  credit  by  hoarding 
gold  instead  of  using  it  to  pay  his  debts.  So  long  as  gold 
is  the  money  of  the  world,  the  world's  debts  are  payable 
in  gold — such  as  are  not  cancelled  by  the  exchange  of 
goods.  Hoarding  of  gold  is  therefore  of  no  value  as  a 
business  or  economic  expedient,  if  the  purpose  of  the 
hoarding  is  merely  to  accumulate  "wealth."  If  the  supply 
of  currency  is  deficient,  however,  the  accumulation  of  a 
gold  reserve  against  which  notes  may  be  issued  may  be 
justifiable. 

An  excellent  illustration  of  the  economic  effect  of 
checking  the  movement  of  gold  between  countries  is  seen 
in  the  rate  of  exchange  for  Spanish  pesetas — of  a  mint 
par  of  19.30  cents,  but  which  exchanged  during  the  war 
for  30  cents.  Importers  of  goods  from  Spain  could  not 
ship  gold,  because  of  the  embargo.     The  balance  of  trade 


EXCHANGE  67Z 

as  between  Spain  and  the  United  States  was  very  favor- 
able to  the  United  States;  yet  the  rate  of  exchange  was 
very  favorable  to  Spain,  because  the  United  States  could 
not  ship  gold  to  Spain  to  settle  its  obligations.  As  be- 
tween Spain  and  England,  however,  the  trade  balance  was 
in  favor  of  Spain,  and  sterhng  was  cheap  in  Spain.  Spain, 
accordingly,  bought  sterling  exchange  at  home  where  it 
was  cheap  and  used  it  to  settle  accounts  in  the  United 
States  where  sterling  was  practically  at  par,  because  it 
had  been  "pegged." 

\"arious  plans  involving  international  co-operation 
have  been  suggested  for  stabilizing  rates  of  exchvinge. 

Rates  of  exchange  on  important  countries.  — The 
most  important  rate  of  exchange  is  that  on  London.  In 
New  York,  the  rate  on  London  is  the  price  in  dollars  and 
cents  which  must  be  paid  for  each  pound  sterling  of  a 
sizable  draft,  payable  on  presentation,  drawn  by  a  banker 
in  New  York  on  a  banker  in  London. 

One  pound  sterling  contains  as  much  fine  gold  as  4.8665 
standard  U.  S.  gold  dollars.  The  par  of  exchange  be- 
tween New  York  and  London,  accordingly,  is  4.8665. 
In  practice,  the  market  rates  are  quoted  in  a  progression 
of  J^  of  a  cent  per  pound  sterling,  as  4.86,  4.86^, 
4.8634.  and  so  on.  There  is  a  tendency  to  quote  in  1/20 
of  a  cent,  on  a  decimal  scale,  instead  of  by  the  orthodox 
progression.  On  £10,000  a  change  of  ^  of  a  cent  in 
the  rate  makes  a  difference  of  $12.50.  A  change  of  1/20 
of  a  cent,  as  from  4.8605  to  4.8610  makes  a  difference 
of  $5  on  the  same  (£10,000).  For  the  period  of  the  war 
the  rate  was  arbitrarily  "pegged"  at  4.76  7/16,  by  agree- 
ment of  England,  France  and  the  United  States,     When 


674  PRINCIPLES  OF  BUSINESS 

the  peg  was  removed  on  March  20,  191 9,  the  rate  fell  till 
it  reached  $3.20  on  February  4,  1920.  A  normal  daily 
fluctuation  was  15  points,  or  $15  on  £10,000. 

The  rate  of  exchange  on  Paris  used  to  be  quoted  in  the 
form  of  the  number  of  francs  that  could  be  purchased 
with  an  American  dollar.  At  New  York  a  quotation  of 
5.18^  meant  that  five  francs  and  i8>8  centimes  could 
be  purchased  for  a  dollar.  The  system  has  been  changed, 
however,  and  the  franc  is  now  quoted  in  what  it  is  worth 
in  American  money,  as  so  many  cents,  mills,  tenths  of  a 
mill,  and  fraction  thereof. 

Before  the  war  the  rate  of  exchange  on  Berlin  was  in 
so  many  American  cents  for  four  Reichsmarks,  or 
"marks"  as  they  are  commonly  called.  They  are  now 
quoted,  however,  on  the  basis  of  their  value  in  American 
money,  and  since  German  currency  has  become  inordi- 
nately inflated,  the  mark  has  fallen  below  one  cent  in  value 
at  the  time  this  is  being  written.  It  is  generally  felt  that 
as  in  the  case  of  the  assignats  following  the  French  Revo- 
lution, the  mark  will  disappear,  its  place  being  taken  by 
some  other  unit  of  currency  that  will  be  exchangeable  for 
the  then  existing  marks  at  a  rate  so  high  that  the  latter 
will  have  little  value  at  all. 

Exchange  and  the  balance  of  trade. — The  rate  of  ex- 
change, in  normal  times,  is  determined  by  the  balance  of 
trade,  within  the  limits  fixed  by  the  cost  of  shipping  gold. 
Theoretically,  the  balance  of  trade,  in  turn,  responds  to 
the  influence  of  the  rates  of  exchange.  As  the  rate  of 
exchange  increases,  buying  from  abroad  tends  to  decline. 
Exports  accordingly  fall  off,  and  the  demand  for  ex- 
change is  lessened,  decreasing  the  rate.     The  rate  tends 


EXCHANGE  675 

to  fall  until  the  point  is  reached  where  it  will  be  profitable 
for  foreign  countries  to  resume  buying,  whereupon  buy- 
ing increases  and  the  rate  of  exchange  moves  upward. 

It  is  essential,  in  normal  times,  that  the  movement  of 
gold  shall  not  be  restricted,  for  in  such  a  case  the  rates 
may  rise  to  a  prohibitive  point,  as  in  the  case  of  exchange 
on  Spain. 

Arbitraging. — From  the  foregoing  it  will  be  seen  that 
the  rates  of  exchange  on  each  country  with  respect  to  any 
other  country  are  continually  changing  with  the  changes 
in  the  balance  of  trade.  Under  normal  conditions,  there 
are  two  influences  affecting  the  rates  of  exchange — the 
shifting  trade-balances,  tending  to  disturb  the  equilibrium 
of  the  rates ;  and  the  traffic  in  exchange,  tending  to  equal- 
ize the  rates.  By  equalization  of  the  rates,  we  do  not 
mean,  of  course,  a  bringing  about  of  uniformity  in  the 
rates,  but  only  consistency.  For  example,  if  the  position 
of  A,  with  reference  to  its  rates  of  exchange,  is  unfavor- 
able with  respect  to'  B,  its  position  tends  to  become  equally 
unfavorable  with  respect  to  the  other  countries,  C,  D 
and  E. 

Now  the  rates  between  the  "gold  points"  are  deter- 
mined ultimately  by  the  general  balance  of  trade,  but 
more  immediately  by  the  corresponding  balance  of  ex- 
change, which  is  adjusted  largely  by  means  of  transfers 
of  money,  or  credit,  through  the  mails.  Pending  this  ad- 
justment, there  is  a  discrepancy  in  the  rates  prevailing 
between  the  different  countries.^ 

^  This  adjustment,  of  course,  represents  merely  the  composite 
resuh  of  past  conditions.  Later  conditions  compel  new  adjustments-, 
so  that  with  respect  to  conditions  at  any  given  time,  there  is  only  a 
"tendency"   toward   adjustment. 


676  PRINCIPLES  OF  BUSINESS 

Since  money  payable  at  a  given  place  may  be  pur- 
chased, at  any  given  time,  more  cheaply  at  some  one  place 
than  elsewhere,  there  is  an  opportunity  for  an  alert  dealer 
in  exchange  to  purchase  the  cheaper  money,  by  cable,  and 
sell  it  where  the  price  is  higher.  This  process  is  called 
"arbitraging.''  The  arbitrageur  need  not  limit  his  series- 
transaction  to  the  "triangle"  formed  by  his  own  city,  the 
city  where  money  is  bought,  and  the  city  where  the  money 
is  sold — that  is,  paid.  He  may,  for  example,  see  a  profit 
in  buying  exchange  on  Italy,  converting  that  into  ex- 
change on  Spain,  and  that  into  exchange  on  London,  and 
that,  finally,  into  exchange  on  Paris.  Each  such  trans- 
action, of  course,  hastens  the  equalization  of  the  rates 
as  between  the  various  countries  involved. 

The  arbitrageur  is  not  a  speculator — he  merely  takes 
immediate  advantage  of  an  existing  and  known  state  of 
the  market.  Such  facilities  as  the  arbitrageur  possesses 
are  not  to  be  had  by  everyone ;  an  elaborate  mechanism 
must  be  maintained  for  carrying  on  such  transactions. 

Dealers  in  foreign  exchange. — Obviously,  those  who 
deal  in  exchange  do  so  in  order  that  they  may  make  a 
profit.  It  would  seem  that  there  are  three  ways  in  which 
a  profit  can  be  made :  ( i )  in  the  charge  for  services  ren- 
dered to  those  who  have  payments  to  make;  (2)  in  arbi- 
traging,  as  described  above;  and  (3)  in  anticipating  a  rise 
in  the  price  of  exchange.     The  latter  is  speculation. 

The  dealers  in  exchange  are  of  three  general  classes : 
'( I )  bankers  who  actually  receive  and  transmit  exchange 
as  between  the  different  financial  centers;  (2)  local 
dealers,  who  buy  bills  of  exchange  and  sell  them  to  for- 
eign exchange  bankers;  and   (3)   brokers,  who  receive 


EXCHANGE  677 

merely  a  commission  for  bringing  buyers  and  sellers  to- 
gether/ 

Operations  in  foreign  exchange. — In  addition  to 
arbitraging  (which  was  described  above,  in  order  that  an 
outline  of  the  conditions  affecting  rates  of  exchange  might 
at  the  same  time  be  given),  the  operations  typical  of 
transactions  in  foreign  exchange  would  include  the  fol- 
lowing :- 

1.  Demand  against  demand.  The  simplest  form  of 
dealing  in  exchange  is  illustrated  when  the  banker  buys 
demand  bills  at  a  given  price  and  sells  his  own  demand 
drafts  against  them  at  a  higher  price.  The  banker  may 
have  a  client  whose  credit  he  knows  to  be  perfectly  good, 
but  the  market  value  of  whose  credit  is  less  than  that  of 
the  banker's  own  credit.  The  banker,  accordingly,  buys 
his  client's  credit  and  sells  his  own,  making  as  his  profit 
the  difference  in  the  market  values,  for  his  client's  credit, 
in  the  form  of  a  sight  draft,  will  answer  for  the  replen- 
ishing of  the  banker's  credit  balance  abroad  fully  as  well 
as  would  his  own  draft. 

2.  Cables  against  demand.  A  similar  transaction  is 
the  selling  of  cables  against  demand  drafts.  The  banker 
may  have  an  adequate  balance  abroad,  and  can  replenish 
it  to  the  extent  to  which  the  cable  depletes  it  by  sending 
thither  the  client's  demand  draft,  which  he  has  purchased 
for  a  price  less  than  that  for  which  he  has  sold  his  own 
"cable." 

3.  Demand  against  long  bills.  A  third  kind  of  trans- 
action is  the  selling  of  a  demand  draft  against  a  commer- 

1  Brown,  International  Trade  and  Exchange. 

2  See  Franklin  Escher,  Elements  of  Foreign  Exchange. 


678  PRINCIPLES  OF  BUSINESS 

cial  long  bill.  This  may  be  a  speculative  transaction,  the 
banker  taking  a  chance  on  a  rise  in  the  rate  of  exchange 
by  the  time  the  bill  matures  and  is  paid  to  his  credit 
abroad;  or  he  may  ascertain  the  discount  rate  on  such  a 
bill  "to  arrive"  by  a  certain  steamer,  and  instruct  that  the 
bill  be  discounted  immediately  upon  its  arrival  and  the 
proceeds  put  to  his  credit.  Whether  or  not  it  will  pay  the 
banker  to  sell  his  own  demand  draft  will  then  appear  from 
the  price  he  can  get  for  a  demand  draft,  on  the  one  hand, 
and  from  the  net  proceeds  of  the  long  bill,  on  the  other 
hand. 

4.  Foreign  loans.  When  interest  rates  are  higher  in 
one  country  than  in  another,  capital  for  investment  moves 
to  the  country  where  the  higher  rates  prevail.  The  trans- 
fer is  accomplished  by  means  of  foreign  exchange.  There 
may  be  also  a  seasonal  demand  for  short-term  loans,  as 
well  as  a  more  permanent  demand  for  investment  loans. 

The  banker  in  a  city  where  capital  is  seeking  invest- 
ment, when  he  observes  the  rise  in  interest  rates  else- 
where, may  cable  his  correspondent  at  such  a  place  to  draw 
upon  him  at  60  or  90  days'  sight  for  a  stated  sum  and  in- 
vest the  proceeds  of  the  sale  of  the  draft  in  specified  se- 
curities or  classes  of  securities.  He  may  take  this  action 
either  upon  the  direct  instructions  of  clients  who  desire 
investments,  or  may  do  so  upon  his  own  initiative,  in  the 
expectation  of  selling  the  securities  so  purchased  abroad 
by  the  time  his  draft  matures. 

5.  The  last  of  our  so-called  typical  operations  in  for- 
eign exchange  (arbitraging  being  considered  in  a  previous 
section)  is  the  drawing  of  finance  bills.  A  finance  bill, 
as  defined  by  Franklin  Escher  in  his  "Elements  of  For- 


EXCHANGE  679 

eign  Exchange,"  is  "a  long  draft  drawn  by  a  banker  of 
one  country  on  a  banker  in  another,  sometimes  secured 
by  collateral,  but  more  often  not,  and  issued  by  the  draw- 
ing banker  for  the  purpose  of  raising  money."  Such 
bills,  Mr.  Escher  points  out,  are  not  always  distinguish- 
able, superficially,  from  the  bills  drawn  for  the  financing 
of  imports  and  exports,  but  essentially  they  are  different, 
for  they  are  undoubtedly  of  a  speculative  nature. 
Whether  or  not  any  collateral  is  put  up,  the  whole  pur- 
pose of  the  drawing  of  finance  bills  is  to  provide  an  -easy 
way  of  raising  money  without  borrowing  from  another 
local  bank.  The  drawer  of  the  finance  bill,  always  a 
banker  in  excellent  standing  both  in  his  own  city  and 
abroad,  arranges  with  a  foreign  bank  to  "accept"  his 
drafts  up  to  a  certain  amount.  Usually  no  additional 
collateral  is  required,  for  such  an  arrangement  will  be 
made  only  with  a  banker  whose  credit  is  good.  The  bor- 
rowing banker  may,  for  example,  foresee  a  decline  in  the 
rate  of  exchange  on  the  place  against  which  he  proposes 
to  draw  his  finance  bill,  due  to  expected  crop  movements 
or  other  export  factors.  By  drawing  bills  at  ninety 
days  and  "covering"  when  the  decline  comes,  he  may 
make  such  a  profit  as  amounts  to  the  same  thing  as  his 
having  had  the  free  use  of  the  borrowed  money  for  the 
ninety  days.  The  customary  minimum  amount  of  such 
a  loan  is  £io,ooD,  and  when  a  number  of  finance  bills  are 
drawn  at  about  the  same  time,  they  may  depress  the  rate 
of  exchange,  whereas  a  fairly  high  rate  must  be  realized 
if  the  loan  is  to  be  profitable. 

When  the  loans  are  to  be  repaid,  "cover"  paper  may  be 
difficult  to  secure,,  for  the  holders  of  suitable  cover  paper 


68o  PRINCIPLES  OF  BUSINESS 

may  take  advantage  of  the  situation  and  ask  a  ver}'-  high 
price  for.  their  bills.  A  safe  practice,  when  a  finance  bill 
is  drawn,  is  to  buy  cover  paper  for  future  delivery. 

Exchange  on  silver-standard  countries. — Most  of 
the  world  is  on  a  gold  monetary  basis,  but  China  and  a 
few  other  Eastern  countries  are  on  a  silver  basis.  China 
is  the  only  one  of  importance. 

The  rate  of  exchange  between  a  gold-standard  country 
and  a  silver-standard  country  is  complicated  by  the  fact 
that  it  is  not  determined  by  supply  and  demand  alone,  but 
also  by  the  relative  values  of  gold  and  silver.  If  an  in- 
vestor lends  money  in  a  silver-standard  country,  he  lends 
gold  in  an  amount  measured  by  the  price  of  silver.  If 
by  the  time  his  loan  matures  the  price  of  silver  has  fallen, 
he  will  receive  in  repayment  less  gold  than  he  lent,  be- 
cause he  is  repaid  in  the  standard  money  of  the  borrower's 
country,  converted  into  the  monetary  unit  of  his  own 
country. 

The  difficulty  and  uncertainty  incident  to  a  double 
monetary  standard  in  foreign  exchange  has  forced  prac- 
.tically  the  entire  world,  with  the  exception  of  the  East, 
to  adopt  the  gold  standard.  Even  most  of  the  Latin- 
American  countries  are  nominally  on  a  gold  basis,  but  the 
lack  of  actual  convertibility  of  their  currency  into  the 
gold  in  which  it  is  nominally  redeemable  causes  great 
increases  in  their  rates  of  exchange.  Currency  issued 
against  gold  but  which  cannot  actually  be  redeemed  in 
gold  differs  but  little  from  fiat  money. 

Sterling  exchange  and  dollar  credits. — Sterling  ex- 
change has  become  the  world's  currency,  directly  because 
of  the  exchange  facilities  afforded  by  London,  with  cor- 


EXCHANGE  68 1 

respondent  banks  in  the  remotest  corners  of  the  earth. 
The  facihties  themselves,  of  course,  are  the  consequence 
of  the  extension  of  British  trade.  It  would,  obviously, 
be  impossible  for  a  country  to  maintain  exchange  facilities 
without  traffic  in  goods.  The  Federal  Reserve  system 
with  its  foreign  branches  furnishes  facilities  for  trans- 
acting exchange  in  terms  of  United  States  dollars.  The 
following  countries  have  been  designated  as  those  from 
which  member  banks  may  accept  drafts  for  the  purpose 
of  furnishing  dollar  exchange :  Argentina,  Bolivia,  Bra- 
zil, British  Guiana,  British  Honduras,  Chile,  Colombia, 
Costa  Rica,  Cuba,  Dutch  Guiana,  Ecuador,  French 
Guiana,  Guatemala,  Honduras.  Nicaragua,  Panama, 
Paraguay,  Peru,  Porto  Rico,  San  Salvador,  Santo  Do- 
mingo, Trinidad,  Uruguay,  Venezuela,  Australia,  New 
Zealand,  and  other  Australasian  dependencies. 

Other  things  being  equal,  the  preference  for  one  form 
of  money  over  another  is  largely  a  matter  of  habit.  Gold 
has  always  been  the  preferred  currency  on  the  Pacific 
Coast,  silver  in  the  Southwest,  and  paper  money  in  the 
East.  The  world  has,  undeniably,  acquired  the  habit  of 
transacting  its  international  business  in  sterling.  The 
psychological  factors  will  favor  the  retention  of  sterling, 
until  a  positive  advantage  is  seen  in  the  use  of  the  dollar. 
Such  an  advantage,  if  it  is  to  materialize,  will  be  princi- 
pally in  the  stability  of  the  dollar,  the  cost  of  the  dollar, 
and  the  facilities  for  payment  in  the  dollar. 

It  would  seem,  in  a  way.  that  there  would  be  a  disad- 
vantage in  having  two  kinds  of  money  in  circulation  at 
the  same  place  and  at  the  same  time.  If  they  exchanged 
at  different  rates,  inconvenience  would  result;  if  they  ex- 


682  PRINCIPLES  OF  BUSINESS 

changed  at  the  same  rate,  neither  would  have  the  advan- 
tage— they  would  be,  to  all  purposes,  the  same  form  of; 
money.  One  of  the  prime  requisites  of  money,  as  the 
universal  medium  of  exchange,  is  certainty  as  to  its  value. 
Two  currencies  in  world  commerce,  although  each  were 
based  on  gold,  would  be  somewhat  the  same  as  a  double 
standard  in  an  individual  country.  It  will  be  difficult, 
apparently,  for  two  forms  of  exchange-currency  to  exist 
side  by  side.  It  would  seem  that  sterling  must  maintain 
its  supremacy,  or  else  be  displaced  by  the  dollar. 

Regardless,  however,  of  the  competition  between  the 
dollar  and  other  measures  of  value  in  exchange,  the  use 
of  dollar  credits  will  be  economical  in  transactions  of 
countries  direct  with  the  United  States.  If  suitable  ex- 
change facilities,  widely  enough  distributed,  are  provided 
by  the  Federal  Reserve  system  for  the  discount  of  bills 
drawn  upon  the  United  States,  the  conversion  of  the 
credits  involved  can  be  accomplished  more  economically 
than  through  the  intermediation  of  a  third  party  at  a 
distance. 

The  price  of  goods,  ©f  course,  must  continue  to  be  regu- 
lated by  the  action  of  supply  and  demand.  If  price- 
fixing  should  be  extended  on  a  scale  not  heretofore 
contemplated  even  under  emergency  conditions,  such  a 
price-fixing  would  be  no  more  than  an  interpretation  of 
economic  laws.  There  is,  however,  no  fundamental  jus- 
tification for  variations  in  the  "value"  of  money.  The 
variations  do  not  reflect  the  prices  of  goods  directly,  but 
only  indirectly,  in  so  far  as  the  demand  for  goods  in- 
creases the  demand  for  a  medium  of  exchange  with  which 
to  pay  for  the  goods.     There  is  no  fundamental  reason 


EXCHANGE  683 

why  money  should  not  exchange  at  par  throughout  the 
world,  as  it  is  intended  to  do  throughout  the  United 
States  under  the  Federal  Reserve  system.  The  cost  of 
transferring  funds,  in  other  words,  is  an  economic  waste, 
since  funds  could  be  transported,  under  an  efficient  credit- 
system,  at  practically  no  cost  at  all. 

A  world  credit-exchange,'  maintained  by  the  several 
governments,  would  probably  eliminate  the  cost  of  ex- 
changing money — the  more  probably  if  the  nations  were 
to  agree  upon  what  has  often  been  proposed — a  common 
monetary  system,  or  standardized  coinage.  The  "Brit- 
ishers," of  course,  would  be  reluctant  to  give  up  their 
pounds,  shillings  and  pence,  to  say  nothing  of  their 
crowns,  guineas,  and  sovereigns.  The  French  would  be 
slow  to  part  with  their  francs.  Naturally,  we  of  the 
United  States  may  feel  that  in  the  event  of  the  adoption 
of  a  common  monetary  unit  we  should  not  be  required 
to  surrender  anything  that  was  dear  to  us,  for  surely  no 
better  unit  than  the  U.  S.  dollar  could  be  devised,  to  serve 
as  the  standard  of  the  world's  currency. 

BIBLIOGRAPHY 

Escher,  Franklin,  Foreign  Exchange  Explained. 
Spaulding,  W.  F.,  Foreign  Exchange  and  Foreign  Bills. 
Gonzales,  V.,  Modern  Foreign  Exchange. 
Todd,  J.  A.,  The  Mcclianism  of  Exchange. 
Withers,  Hartley,  War  and  Lombard  Street. 
Withers,  Hartley,  The  Business  of  Finance. 
Clare,  George,  The  A.  B.  C.  of  Foreign  E.vchange. 
Brown,  H.  G.,  International  Trade  and  Exchange. 
Margraff,  A.  W.,  International  Excliangc. 

Anderson,  B.  AI.,  Effects  of  the  War  on  Money,  Credit  and  Banking 
in  France  and  the   United  States. 
Spalding,  \V.  F.,  Eastern  Exchange,  Currency  and  Finance. 


CHAPTER    XXIX 

PRINCIPLES  OF  ACCOUNTING 

What  is  accounting? — Accounting  has  been  defined 
as  "the  science  dealing  with  the  recording,  verification, 
and  presentation  of  facts,  involving  the  acquisition,  pro- 
duction, conservation  and  transfer  of  values."  ^  In  a 
word,  it  is  the  science  of  analyzing  and  recording  business 
transactions  in  such  a  manner  as  to  furnish  tlie  greatest 
amount  of  information  about  each  transaction,  in  particu- 
lar, and  the  business  as  a  unit,  in  general. 

Uses  of  accounting. — Accounting  records  invariably 
form  the  basis  for  important  decisions  in  the  financing 
and  general  conduct  of  an  enterprise. 

In  a  business  enterprise  of  any  size  it  is  usually  found 
that  the  co-owners  or  investors  are  divided  into  classes, 
each  of  which  assumes  a  different  degree  of  risk  and  has 
a  different  degree  of  priority  or  right  to  the  income 
earned  by  the  enterprise,  the  legal  rights  of  each  class 
depending  upon  the  agreement  made.  Justice  cannot 
be  done  to  all  classes  except  through  accurate  accounting. 

Government  regulation  of  business,  likewise,  with  re- 
spect to  its  equitableness  and  success,  is  dependent  upon 
accounting. 

In  the  case  of  the  combinations  of  corporations 
by  means  of  mergers,  consolidations  or  holding  com- 
panies, accounting  plays  an  important  part.  While  the 
distribution   of    securities    is    largely   a   matter   of    bar- 

'^Certified  Public  Accountant  Syllabus,  issued  by  the  New  York 
State  Department  of  Education. 

68s 


686  PRINCIPLES  OF  BUSINESS 

gaining  and  financial  adjustments,  it  is  nevertheless  true 
that  the  promoter  and  other  parties  interested  have  no 
sound  basis  for  conducting  negotiations  unless  there  is 
available  a  statement  of  the  present  condition  and  of  the 
past  and  present  earnings  of  the  component  companies. 
Development  of  accounting. — In  ancient  times,  ac- 
counting served  primarily  merely  to  record  the  obliga- 
tion of  one  person  to  another.  The  Babylonian,  for  ex- 
ample, was  satisfied  to  discard  his  records  after  he 
had  made  collection  of  whatever  was  due  him.  Beyond 
that,  he  found  that  records  were  unnecessary,  since  his 
business  dealings  were  limited  and  since  he  had  little  diffi- 
culty in  remembering  all  the  facts  having  to  do  with  his 
commercial  dealings.  In  fact,  until  recently,  the  business 
man  looked  upon  the  keeping  of  records  as  an  unnecessary 
trouble  and  expense.  He  was  satisfied,  for  example, 
to  know  that  the  business  had  shown  an  apparent  profit 
of  so  many  dollars  at  the  end  of  the  year,  and  depending 
upon  whether  or  not  tliis  amount  of  profit  was  satisfac- 
tory, he  would  decide  to  take  his  profits  and  reduce 
the  scale  of  his  operations,  or  else  to  leave  tfie  profits  in 
the  business  and  take  another  chance  on  the  future. 
Today,  however,  the  whole  problem  is  different.  With 
the  advent  of  the  large  and  complicated  modern  business 
enterprise,  there  is  still  the  elementary  need  for  data  to 
serve  as  evidences  of  rights  and  obligations,  but  more  im- 
portant is  the  need  for  a  complete  general  plan  of  record- 
keeping and  classification  of  information  by  means  of 
which  all  the  activities  of  the  business  may  be  intelligently 
controlled.  The  executive  can  no  longer  hope  to  super- 
vise the  detailed  operation  of  a  business  of  any  consider- 


PRINCIPLES    OF   ACCOUNTING  687 

able  size.  He  must  deal  only  with  the  fundamentals. 
He  must  have  a  comprehensive  view  of  the  organization, 
so  that  he  may  detect  the  weaknesses  and  plan  to  remove 
them.  It  is  through  accounting  records  that  this  is  made 
possible.  The  three  important  steps  in  the  improvement 
of  the  organization  are,  accordingly :  first,  the  designing 
of  a  system  that  permits  of  gathering  the  necessary  in- 
formation ;  second,  the  accurate  recording  of  this  infor- 
mation; and,  finally,  the  proper  interpretation  of  facts  on 
which  conclusions  and  plans  for  improvement  may  be 
based. 

BOOKKEEPING  PRINCIPLES 

Bookkeeping  principles. — The   analysis   of  business 
transactions  is  not  serviceable  unless  the  results  of  the 
analysis   are  properly   recorded   in  an   intelligent   form. 
The  process  of  recording  business  transactions  is  called 
bookkeeping.      The    prevalent    doubk-entry    system    of 
bookkeeping  is  based  upon  the  equation : 
Goods  Owned  =  Proprietorship. 
Expressed  in  accounting  terms,  the  equation  would  be : 
Assets  =:  Proprietorship. 
But  this  equation  is  true  only  if  one  owes  nothing.   Other- 
wise, the  equation  should  be : 

Assets  —  Liabilities  =  Proprietorship. 
In  bookkeeping,  the  equation  would  be  changed  to: 

Assets  =  Liabilities  -|-  Proprietorship. 
This  equation  holds  true  for  every  double-entry  set  of 
books  at  all  times.  For  convenience,  the  items  to  the  left 
of  the  equation  are  called  debits;  those  to  the  right, 
credits.  If  John  Smith  were  to  start  business  with  $100 
in  cash  the  opening  would  be : 


688  PRINCIPLES  OF  BUSINESS 

Dr.      Cash      $100=  Cr.  John  Smith,  Proprietor      $100 

Now  subsequent  transactions  in  cash  would  be  entered 
under  the  cash  account.     If  John  Smith  uses  $50  to  pur- 
chase merchandise,  his  cash  would  be  reduced  by  $50, 
but  he  would  have  another  asset  called  merchandise.^ 
The  transaction  would  be  entered  as  follows ; 

Dr.     Merchandise  $50=Cr.     Cash  $50. 

The  effect  of  crediting  cash  $50  is  the  same  as  sub- 
tracting $50  from  the  debit.  In  bookkeeping,  then,  if  it 
is  desired  to  reduce  the  amount  standing  on  one  side  of 
the  equation,  the  amount  should  be  entered  on  the  oppo- 
site side.  Thus,  we  had  $100  cash  on  the  debit  side  of 
the  equation,  which  we  desired  to  reduce  by  $50.  This 
was  done  by  crediting  cash  $50. 

If  $25  of  the  merchandise  is  sold  to  Will  Brown  for 
$35  o^  30  days'  time,  the  asset  "merchandise"  will  have 
been  decreased  $25,  but  this  decrease  is  offset  by  the  ac- 
quisition of  a  new  asset — the  claim  against  Will  Brown 
for  $35.  The  asset  received  is  $10  greater  than  that 
given  up;  it  is  evident,  therefore,  that  the  proprietorship 
has  been  increased  by  $10.  The  transaction  would  be 
entered  as  follows : 

•r>     wru  X3  <t^r- f  Cr.  Merchandise    $25. 

Dr.  Will  Brown  $35-   jcr.John  Smith,  Proprietor  $10. 

Now  let  us  assume  that  John  Smith  pays  out  $5  for  the 
wages  of  a  clerk.  As  he  has  received  no  asset  in  ex- 
change for  the  $5,  we  must  infer  that  his  proprietorship 

1  The  rule  in  bookkeeping  is  that  when  an  asset  is  increased, 
debit  the  asset  account  by  that  amount,  and  conversely  when  it  is 
decreased  credit  the  account.  Likewise  when  a  liability  is  increased, 
the  liability  account  should  be  credited,  and  when  decreased  it 
should  be  debited. 


PRINCIPLES    OF   ACCOUNTING  689 

has  been  decreased  by  the  amount  of  $5.     The  proper 
entry  would  be : 

Dr.  John  Smith,  Proprietor  $5  =  Cr.  Cash,  $5 
If  we  now  group  all  the  transactions  affecting  each 
asset,  the  result  of  the  debits  and  credits  will  be  as  fol- 
lows : 

Assets 

Cash   $  45 

Merchandise    25 

Will  Brown 35 


Total    Assets $105  =  Proprietorship  $105 

By  grouping  all  the  transactions  affecting  a  given  asset, 
we  create  an  account.  Thus  the  cash  account  containing 
the  preceding  transactions  would  look  like  this : 

Cash 

Investment $100    — 

Alerchandise $  50     — 

Wages    5     — 

Balance    45     — 

Total $100     —  Total  $100    — 

Balance  $  45     — 

This  procedure — of  entering  the  changes  in  proprietor- 
ship in  the  proprietor's  account — could  be  followed  in- 
definitely, and  the  proprietor's  account  would  always 
show  the  difference  between  the  assets  owned  and  the 
liabilities  owed.  As  the  business  increased  it  would  be- 
come difficult  to  determine  how  much  of  the  sales  re- 
ceipts for  merchandise  represented  cost  and  how  much 
was  profit.  It  is  also  evident  that  if  all  transactions  re- 
sulting in  an  increase  or  decrease  of  proprietorship  are 
reflected  in  the  proprietor's  account  it  would  be  difficult 
to  decide  at  the  end  of  the  period  the  extent  to  which  each 


690  PRINCIPLES  OF  BUSINESS 

cause  contributed  to  the  net  increase  or  decrease  of  pro- 
prietorship. To  save  this  confusion  and  to  furnish  addi- 
tional information  we  change  our  method  of  entering 
transactions  so  that  instead  of  crediting  or  debiting  pro- 
prietorship with  each  change,  we  credit  or  debit  accounts 
whose  titles  indicate  the  causes  of  the  increases  or  de- 
creases. Thus,  when  $5  is  spent  for  wages  the  entry 
would  be : 

Dr.     Wages     $5  Cr.  Cash        $5 

This  entry  would  show  that  because  of  paying  wages  the 
proprietorship  was  reduced  $5.  On  the  other  hand,  if 
$5  was  received  for  interest,  the  entry  would  be : 

Dr.     Cash       $5  Cr.  Interest   $5 

This  indicates  that  the  proprietorship  had  been  increased 
by  the  amount  of  interest  received. 

At  the  close  of  each  fiscal  period  (which  may  be  a 
month,  half-year  or  year)  nominal  accounts — that  is,  all 
the  accounts,  such  as  rent,  interest,  wages,  or  taxes,  re- 
flecting a  change  in  the  financial  condition  of  proprietor- 
ship of  the  business,  are  transferred  to  another  account 
called  the  "profit  and  loss  account.''  This  account  then 
contains  a  summary  of  the  causes  of  the  changes  in  pro- 
prietorship and  from  this  account  the  net  increase  or  de- 
crease is  transferred  or  "closed  out"  to  the  "proprietor- 
ship" account.  The  transferring  of  the  nominal  accounts 
to  the  profit  and  loss  account  and  finally  to  the  proprietor- 
ship account  is  called  "closing  the  books.''  After  the 
books  have  been  "closed"  the  only  accounts  open  are  the 
real  accounts  consisting  of  the  assets,  the  liabilities  and 
the  proprietorship — that  is,  the  accounts  which  show  the 
financial   condition   of  the  business. 


PRINCIPLES    OF   ACCOUNTING  691 

The  merchandise  account. — As  indicated  above,  it  is 
often  impracticable  to  determine  at  the  time  of  the  sale 
the  profit  on  each  sale  of  merchandise.  In  such  cases  the 
sales  are  entered  as  if  the  entire  sales  price  represented 
cost.  Thus  a  cash  sale  of  merchandise  for  $35  would  be 
entered : 

Dr.     Cash    $35  Cr.  Alerchandise    $35 

If  the  original  purchases  amounted  to  $100  the  mer- 
chandise account  would  appear  as  follows : 

Merchandise  Account 


Purchases  $100  j  Sales  $35 
This  would  indicate  that  we  should  have  on  hand  mer- 
chandise amounting  to  $65.  This  condition  would  exist 
only  if  the  merchandise  sold  for  $35  had  cost  exactly  that 
amount.  Before  we  can  determine  whether  or  not  we 
have  made  a  profit  on  the  sale,  an  inventory  myst  be  taken 
to  find  out  how  much  merchandise  is  on  hand.  Until 
such  an  inventory  is  taken  and  entered  upon  the  books 
the  merchandise  account  is  not  a  real  account,  because  it 
does  not  indicate  the  possession  of  $65  worth  of  merchan- 
dise, nor  is  it  a  nominal  account,  because  it  does  not  mean 
that  the  capital  has  been  reduced  by  $65.  It  is  a  mixed 
account,  and  is  meaningless  until  the  inventory  is  entered 
in  the  account.  If  the  inventory  amounted  to  $75  the 
merchandise  account  would  then  be  "closed  out"  as  fol- 
lows : 

Merchandise  Account 


Purchases    $100 

Profit  on  sales  Trans- 
ferred    to      Profit 
and    Loss 10 

$110 
Inventory $75 


Sales  $35 

Inventory  75 

$110 


692  PRINCIPLES  OF  BUSINESS 

The  account  shows  a  profit  of  $10,  which  would  be 
transferred  to  the  profit  and  loss  account. 

The  inventory  of  merchandise  unsold  appears  as  a  debit 
after  the  account  has  been  closed,  for  the  account  is  now 
a  real  account  and  the  debit  balance  represents  an  asset. 

The  successful  business  man  desires  more  information 
than  a  mere  statement  of  his  profit  on  merchandise ;  he 
wants  to  know  the  amount  of  his  sales,  sales  returns,  pur- 
chases and  purchase  returns;  and  for  comparison  with 
other  periods  he  wants  this  information  available  at  all 
times,  and  not  merely  at  the  end  of  the  accounting  period. 
For  this  reason,  it  has  become  the  practice  to  separate  the 
merchandise  account  into  a  number  of  accounts,  each 
account  covering  one  phase  of  the  transactions  in  mer- 
chandise. The  usual  division  of  accounts  is:  sales,  sales 
returns,  sales  allowances,  purchases,  purchase  returns, 
etc.  At  the  close  of  the  accounting  period  these  accounts 
are  closed  out  into  a  merchandise  trading  account  and 
the  profit  on  merchandise  determined. 

Financial  statements. — After  the  books  are  closed, 
two  financial  statements  are  prepared.  The  first — the 
"balance  sheet" — is  merely  an  arrangement  of  the  assets 
and  liabilities  upon  the  books ;  the  second — the  statement 
of  "income,  profit  and  loss" — is  a  rearrangement  of  the 
profit  and  loss  account.  The  balance  sheet  shows  the 
financial  condition  of  the  business  at  a  given  date,  while 
the  income  statement  summarizes  the  transactions  of  the 
preceding  fiscal  period,  accounting  for  the  change  in  the 
financial  condition  of  the  business.  The  form,  analysis 
and  interpretation  of  these  statements  are  discussed  in  the 
chapter  on  "Financial  Statements  " 


PRINCIPLES    OF   ACCOUNTING 


693 


Books  of  original  entry. — Obviously,  the  first  thing 
to  do  with  a  business  transaction  is  to  make  a  record  of 
it  in  such  detail  that  it  will  always  be  self-explanatory. 
The  old-fashioned  day  book  was  a  book  designed  for  the 
chronological  entry  of  business  transactions.  An  entry 
in  the  day  book  would  read : 


JANUARY  I 

Sold  John  Smith  on  a'c 

2  Bbls.  Apples  @  $5.00      $10.00 

JANUARY  2nd 
Bought  of  A.  B.  &  Co.  on  a/c 
200  Bushels  Potatoes  @  $1.10    $220.00 

From  this  day  book  the  transactions  were  "posted"  to  the 
ledger,  in  which  the  accounts  were  classified.  It  was 
found  that  in  involved  transactions  there  was  a  great 
oportunity  for  error,  because  the  accounts  to  which  the 
postings  were  to  be  made  were  not  indicated  in  the  day 
book.  This  difficulty  has  been  overcome  through  the  use 
of  a  journal,  an  auxiliary  to  the  day  book,  although  some- 
times combined  with  the  day  book  in  the  form  of  a  jour- 
nal day  book,  in  which  are  recorded  the  data  for  posting 
the  elements  of  each  transaction.  The  transactions  illus- 
trated above  would  be  entered  in  the  journal  as  follows: 
Jan. 


Jan. 


John   Smith 

Merchandise 

Merchandise    

A.  B.  &  Co., 


10 

— 

10' 

220 

— 

220 

The  left-hand  column  is  used  to  indicate  debits,  the 
right  to  indicate  credits,  while  the  blank  column  after  the 
date  is  used  to  enter  the  ledger  page  to  which  the  item 
has  been  posted. 

Where  the  day  book  is  combined  with  the  journal  the 


694 


PRINCIPLES  OF  BUSINESS 


journal  entry  is  made  first,  followed  by  the  explanation, 
as  illustrated : 


JANUARY  I 

John    Smith 

Merchandise    

Sold  John  Smith  on  a/c 
2  Bbls.  Apples  @  $5 

—  2  — 

Merchandise    

A.  B.  &  Co 

Bought  of  A.  B.  &  Co.  on  a'c 
200  Bu.  Potatoes  @  $i.io 


$10 


220 


$10 


220 


The  day-book  journal  method  of  entering  transactions 
meant  that  for  each  entry  there  would  be  two  or  more 
postings.  It  was  at  once  seen  that  certain  accounts  were 
affected  more  often  than  others,  and  it  was  therefore  de- 
cided to  enter  the  transactions  having  to  do  with  the 
more  important  accounts  in  separate  books. 

Probably  the  first  class  of  transactions  to  be  entered  in 
a  separate  book  were  those  having  to  do  with  cash.  The 
cash  book  is  usually  divided  into  two  sides,  the  left,  used 
for  cash  receipts,  and  the  right,  used  for  cash  disburse- 
ments. Instead  of  posting  each  item  of  cash  received  to 
the  cash  account,  one  posting  is  made  at  the  end  of  the 
month  of  the  total  cash  received  during  the  month,  and 
a  similar  posting  is  made  of  the  total  cash  disbursed. 

Gradually,  other  transactions  were  grouped  together 
in  special  books,  such  as  sales,  purchases,  sales  returns, 
and  purchase  returns.  Thus  all  entries  in  the  sales  book 
would  be  posted  to  the  debit  of  the  customer's  account, 
while  the  total  sales  would  be  posted  to  the  credit  of  mer- 
chandise. 

"When  the  demand  for  information  made  it  necessary  to 
find  the  sales  in  each  of  several  lines  or  departments,  it 


PRINCIPLES   OF  ACCOUNTING  695 

was  found  that  the  information  could  be  obtained  by 
inserting  additional  columns  in  the  sales  book.  Thus,  if 
the  amount  of  sales  in  each  of,  four  departments  was 
wanted,  the  sales  book  would  be  provided  with  five 
columns,  the  first  for  the  total  sales,  the  others  for  the 
four  departments.  Each  sale  is  entered  in  the  total 
column  and  then  in  the  proper  departmental  column. 
This  principle  of  columnarization  may  be  extended  almost 
indefinitely  to  provide  any.  variety  of  statistical  informa- 
tion. 

What  an  accounting  system  is. — Modern  accounting- 
has  developed  other  forms  of  books  or  original  entry, 
each  one  designed  to  furnish  certain  information.  The 
entire  group  of  books  of  a  business,  including  books  of 
original  entry,  ledgers,  and  subsidiary  records,  such  as 
receiving  and  shipping  records,  is  called  its  accounting 
system. 

Every  accounting  system  should  have  internal  checks, 
that  is,  the  system  should  be  so  designed  that  no  part 
of  the  accounts  will  be  under  the  absolute  and  independent 
control  of  any  one  person ;  that,  on  the  contrary,  the  work 
of  one  employee  will  be  complementary  to  another,  that 
safeguards  will  be  thrown  about  the  handling  of  all 
moneys,  particularly  with  regard  to  such  transactions  as 
cash  sales,  payrolls,  freights,  and  the  like ;  that  the  method 
of.  handling  and  recording  incoming  and  outgoing  goods, 
especially  the  latter,  will  be  such  as  to  insure  that  all 
goods  paid  for  are  actually  received,  and  that  charges  are 
made  to  customers  for  all  goods  shipped.^ 

The  ledger  and  the  trial  balance. — As  previously  ex- 

^  R.  H.  Montgomery,  Auditing,  p. .83. 


696  PRINCIPLES  OF  BUSINESS 

plained,  all  transactions,  after  being  entered  in  the  journal 
or  other  book  of  original  entry,  are  posted  to  the  proper 
accounts  in  the  ledger,,  each  account  being  a  classification 
of  all  the  transactions  of  the  same  or  opposite  tendency. 

The  opening  transaction  of  every  set  of  books  must  be 
an  equation,  the  debits  equalling  the  credits.  And  as  in 
every  succeeding  entry  the  debits  should  equal  the  credits, 
it  follows  that  if  all  entries  have  been  made  properly  and 
posted  correctly,  the  amounts  appearing  on  the  debit  side 
of  the  ledger  should  equal  those  on  the  credit  side.  To 
check  up  the  accuracy  of  the  posting,  a  test  of  the  ledger 
is  made,  usually  at  the  end  of  each  month,  known  as  the 
"trial  balance."  A  trial  balance  is  nothing  but  a  list 
of  the  open  accounts  in  the  ledger  with  the  amount  of  the 
debit  or  credit  balance  (or  debit  and  credit  totals,  if  pre- 
ferred). The  total  debits  and  total  credits  in  the  trial 
balance  should  be  equal.  The  tfial  balance  proves  that 
an  equal  amount  has  been  posted  to  both  sides  of  the 
ledger.  It  does  not  prove  the  accuracy  of  the  posting — 
because  entries,  although  posted  to  the  proper  side  of  the 
ledger,  may  be  posted  to  the  wrong  account,  or  offsetting 
errors  may  be  made,  none  of  which  would  destroy  the 
equilibrium  of  debit  and  credit. 

Controlling  accounts. — We  have  seen  that  when  we 
sell  W.  Brown  $35  worth  of  merchandise  on  credit  our 
entry  is: 

W.   Brown,   Dr $35. 

To  Merchandise,  Cr $35. 

If  we  were  to  open  up  an  account  with  each  person  or 
firm  to  whom  we  sold  merchandise  or  from  whom  we 
purchased  merchandise,  our  ledger  would  soon  grow  to 


PRINCIPLES    OF   ACCOUNTING  697 

unwieldy  proportions.  The  "taking  off"  of  a  trial  bal- 
ance becomes  quite  a  task  and  the  number  of  accounts 
confuses  the  information.  If  there  are  three  or  four 
hundred  accounts  of  customers  and  an  equally  large  num- 
ber of  creditors'  accounts,  it  becomes  difficult  to  determine 
the  total  amount  due  from  customers  and  due  to  creditors. 

To  remedy  these  defects,  controlling  accounts  are 
created  for  customers'  accounts  and  creditors'  accounts, 
and  substituted  for  the  individual  customer's  and  credi- 
tor's accounts  in  the  general  ledger. 

The  controlling  account  for  customers,  called  "accounts 
receivable,"  "due  from  customers,"  or  "customers'  con- 
trolling account,"  shows  in  total  the  debits  and  credits  to 
all  the  customers'  accounts,  and  the  balance  of  the  account 
shows  the  total  amount  due  from  customers.  The  in- 
dividual customer's  accounts  no  longer  form  part  of  the 
general  ledger,  but  are  transferred  to  a  separate  sub- 
sidiary ledger  called  the  customers'  or  accounts  receivable 
ledger.  The  total  of  the  balances  due  from  customers  in 
the  subsidiary  ledger  must  agree  with  the  balance  in  the 
controlling  account  in  the  general  ledger.  In  order  that 
this  agreement  may  exist  it  is  necessary  that  all  amounts 
posted  to  individual  customers'  accounts  be  posted  also 
to  the  controlling  account.  This  posting  is  made  in 
totals  at  the  end  of  each  month  by  means  of  special 
columns  in  the  books  of  original  entry.  Thus,  the  re- 
ceipt side  of  the  cash  book  contains  a  column  in  which 
all  amounts  received  from  customers  are  entered.  The 
amounts  in  this  column  are  posted  to  the  credit  of  the  in- 
dividual customers  and  at  the  end  of  the  month  the  total 
is  credited  to  the  controlling  account  for  customers. 


698  PRINCIPLES  OF  BUSINESS 

The  creditors'  controlling  account — or  "accounts  pay- 
able," as  it  is  often  called — is  operated  in  the  same 
manner.  Controlling  accounts  are  often  kept  for  other 
items,  such  as  investments,  capital  stock,  notes  receivable, 
and  notes  payable.  Under  modern  cost  systems,  as  de- 
scribed in  the  chapter  on  "Cost  Accounting,"  controlling 
accounts  are  kept  for  materials,  work  in  process  and  fin- 
ished goods. 

Single-entry  bookkeeping. — Where  no  attempt  is 
made  to  maintain  the  primary  equation  of  double-entry 
bookkeeping,  i.e.,  assets=liabiliti*es  and  capital,  the  sys- 
tem of  bookkeeping  is  known  as  "single  entry."  In  its 
simplest  form,  single-entry  bookkeeping  consists  merely 
of  keeping  accounts  with  debtors  and  creditors ;  although, 
in  actual  practice,  an  account  with  "cash"  is  also  kept. 
Single-entry  books,  of  themselves,  do  not  show  either  the 
financial  condition  of  the  business  or  the  cause  of  the 
changes  in  the  condition.  The  financial  condition  of  the 
business  can  be  found  only  by  taking  an  actual  inventory 
of  all  physical  assets,  such  as  merchandise  or  real  estate, 
and  taking  these  figures  in  conjunction  with  the  assets 
and  liabilities  shown  on  the  books  and  setting  up  a  state- 
ment of  assets  and  liabilities.  The  profit  for  any  given 
period  is  the  difference  between  the  net  worth  at  the 
beginning  and  that  at  the  end  of  the  period,  plus  the 
amount  withdrawn  by  the  proprietor.  Thus,  if  at  the 
end  of  19 1 8  the  statement  of  assets  and  liabilities  show^s  a 
net  worth  of  $10,000  as  compared  with  $8,000  at  the  be- 
ginning of  the  year,  and  if  the  proprietor  has  drawn 
$2,000  during  the  year,  the  profit  for  the  period  would  be 
$4,000.     The  reason  that  single-entry  bookkeeping  has 


PRINCIPLES    OF   ACCOUNTING  699 

been  supplanted  by  double  entry  is  not  that  it  does  not 
show  the  true  financial  condition  of  the  business ;  for,  as 
pointed  out,  double-entry  books  do  not  do  this  except  at 
inventory  time.  It  is  possible,  of  course,  that  by  not 
having  a  record  of  all  the  assets,  there  is  a  possibility  of 
the  omission  of  some  of  the  assets.  This  chance  of  error 
is  offset  by  the  increased  accuracy  of  the  physical  inven- 
tory of  all  assets.  Nor  can  we  say  that  the  profit  for 
the  period  cannot  be  determined;  for  if  the  proprietorship 
at  the  beginning  and  end  of  the  period  is  correctly  stated, 
the  determination  of  the  profit  or  loss  is  merely  a  matter 
of  subtraction.  The  defect  of  the  single-entry  system 
which  causes  its  condemnation  by  accountants  is  that  it 
does  not  show  the  causes  of  the  changes  in  the  financial 
condition  of  the  business. 

ACCOUNTING  PRINCIPLES 

The  distinction  between  capital  and  revenue. — Real 

accounts  have  been  defined  as  those  accounts  which  re- 
flect the  financial  condition  of  the  business ;  nominal 
accounts,  as  those  accounts  which  reflect  the  changes  in 
the  financial  condition.  Every  transaction  involving  the 
disbursing  of  cash  or  the  incurring  of  liabilities  should  be 
carefully  examined  as  to  whether  or  not  a  corresponding 
asset  has  been  received.  If  we  spend  $1,000  to  purchase 
a  machine  we  have  obviously  received  an  equivalent  asset, 
which  we  charge  to  a  real  or  capital  account  called  ma- 
chinery. On  the  other  hand,  if  we  contribute  $1,000  to 
the  Red  Cross,  it  is  equally  clear  that  we  have  not  re- 
ceived any  equivalent  asset.  ^^'e  therefore  charge  a 
nominal  or  revenue  account,  as  "donations  and  charities." 


700  PRINCIPLES  OF  BUSINESS 

Not  every  transaction  is  so  clear  that  we  can  decide 
definitely  whether  the  charge  should  be  to  capital,  or  to 
revenue.  As  a  matter  of  fact,  nothing  can  be  valued  with 
permanent  certainty.  Even  the  machinery,  which  we  de- 
cided was  an  asset  worth  $i,ooo,  will  require  an  adjust- 
ment in  value  at  the  end  of  the  year  because  of  deprecia- 
tion. It  might  be  argued  that  if  adjustments  must  be 
made  at  the  end  of  each  year  it  is  not  worth  the  trouble 
of  attempting  to  distinguish  between  capital  and  revenue 
as  each  entry  is  made.  But  the  more  carefully  this  dis- 
tinction is  made  each  day,  the  less  will  be  the  labor  of  ad- 
justment at  the  close  of  each  period,  and  the  more  com- 
plete the  information  furnished  by  the  books  in  the  inter- 
vening periods.  The  best  practice  to  follow,  then,  is  to 
charge  to  capital  whatever  is  expected  to  exist  as  an 
asset  at  the  end  of  the  current  earning  period,  and  to 
charge  to  expense  whatever  is  expected  to  be  consumed 
during  the  earning  period. 

But  what  constitutes  an  asset?  Suppose  that  we  own 
a  building  containing  several  stores,  and  a  prospective 
tenant  offers  to  rent  one  of  the  stores  if  we  will  take  out 
the  windows  and  replace  them  with  others  more  suitable 
to  his  business,  which  we  do  at  a  cost  of  $150.  Are  we 
justified  in  charging  this  $150  to  an  asset  account,"  "real 
estate,"  on  the  ground  that  the  property  is  improved? 
If  after  a  year  this  tenant  moves  and  in  order  to  secure 
a  new  tenant  we  replace  the  old  windows  at  a  cost  of 
$100,  are  we  justified  in  charging  this  as  an  asset  to  "real 
estate"  again?  It  is  evident  that  if  we  charged  all  these 
items  to  "real  estate"  and  continued  the  practice  the  real 
estate  account  would  be  increased  without  any  increase  in 


PRINCIPLES   OF   ACCOUNTING  701 

the  value  of  the  property.  These  items  are  expenses,  and 
should  be  charged  against  revenue. 

Or  to  take  the  case  of  a  factory,  may  we  capitalize  the 
cost  of  removing  a  machine  from  one  building  to  another, 
to  permit  of  more  economical  operation? 

It  is  evident  that  while  the  decision  must  depend  upon 
the  circumstances  of  the  particular  case,  there  is  need  for 
a  general  rule  to  guide  us.  Perhaps  the  best  rule  is  that 
in  so  far  as  the  transaction  results  in  an  addition  of  sub- 
stantial and  permanent  character  wdiich  increases  the 
value  of  the  plant,  such  an  increase  is  a  capital  expense.^ 
While  this  view  is  the  one  adopted  by  the  majority  of 
accountants,  other  rules  have  been  laid  down  by  engineers 
and  the  courts.  An  extremely  conservative  view^  is  that 
taken  by  T.  F.  Woodstock  in  an  article  in  the  Engineer- 
ing Magazine'  that  "an  addition  which  does  not  increase 
revenue  or  diminish  expenditures  is  not  a  proper  charge 
against  capital  according  to  the  best  modern  practice  in 
railroads.  That  which  simply  tends  to  hold  business  and 
not  to  increase  business  is  a  proper  charge  against  operat- 
ing expenses.'' 

Another  rule,  which  happily  is  not  followed  by  account- 
ants in  this  country,  laid  down  by  the  court  in  Cox  vs. 
Edinburgh  and  District  Tramways  Company,  Ltd.  (6  S. 
L.  T.  63),  is  that  where  an  improvement  is  made  in  the 
plant  even  though  it  be  in  the  nature  of  a  substitution  of 
new  plant  for  old,  the  entire  cost  of  the  new  plant,  and 
not  merely  the  excess  in  value  of  the  new  over  the  old, 
may  be  capitalized  and  charged  to  construction  account. 

1  MacKintosh  vs.  Flint  &  Pere  Marquette  Ry.  34  Fed.  Rep.  60. 
-  Vol.  XI,  p.  241. 


702  PRINCIPLES  OF  BUSINESS 

Testing  our  hypothetical  cases  by  the  first  rule,  we 
should  capitalize  the  excess  in  value  of  the  new  windows 
over  the  old;  we  should  not  capitalize  the  cost  of  remov- 
ing the  new  windows  nor  should  we  capitalize  the  cost  of 
removing  the  machines  from  one  building  to  another. 

Deferred  charges  to  expense. — In  addition  to  our 
original  classification  of  accounts  as  real  and  nominal 
accounts,  we  have  a  group  of  accounts  which  are  nominal 
in  their  nature,  but  the  charging  of  which  to  expense  is 
deferred  for  accounting  reasons.  These  accounts  are 
called  "deferred  charges  to  expense."  We  may  use  the 
case  of  a  quarry  to  illustrate.  Preparatory  to  getting  out 
rock  it  is  necessary  to  remove  the  loose  earth  or  "top," 
and  for  convenience  the  "top"  is  removed  from  the  entire 
field  before  excavating  is  begun.  Let  us  assume  that  the 
top  is  removed  from  a  particular  bed  which  is  expected 
to  last  three  years.  At  the  end  of  the  first  year  how 
should  the  cost  of  removing  tops  appear  on  the  books? 
Obviously,  it  is  an  expense — a  cost  of  obtaining  revenue 
— and  should  ultimately  be  charged  to  revenue.  Yet  two- 
thirds  of  the  cost  will  benefit  future  periods.  At  the  end 
of  the  first  year  two-thirds  of  the  cost  may  be  counted  as 
an  asset,  whereas  the  remaining  third  should  appear  as 
an  expense  of  production  for  that  year. 

Other  common  examples  of  deferred  charges  to  ex- 
pense  are  organization  expense,  discount  on  bonds,  pre- 
paid rent,  insurance  and  the  like,  all  of  which  are  dis- 
cussed in  the  chapter  on  "Financial  Statements." 

The  important  principle  in  connection  with  these 
charges  is  that  they  should  appear  as  assets  only  so  long 
as  they  represent  some  definite  benefit  available  for  future 


PRINCIPLES   OF   ACCOUNTING  703 

periods  and  that  they  should  be  charged  against  the 
revenue  of  the  different  periods  upon  an  equitable  basis. 

The  anticipation  of  income. — One  of  the  tendencies 
of  the  business  man,  which  it  is  difficult  to  curb,  is  that 
of  anticipating  profits,  of  "counting  his  chickens  before 
they  are  hatched.''  Sometimes  he  will  anticipate  profits 
by  inventorying  finished  goods  at  sales  price  and  raw 
material  at  market  price,  when  such  market  price  is 
greater  than  cost,  and  including  among  his  profits,  esti- 
mated gains  on  uncompleted  contracts. 

Conservative  accounting,  however,  is  opposed  to  these 
practices;  its  rule  is  that  due  provision  must  be  made 
for  all  possible  losses,  while  profits  shall  not  be  considered 
as  earned  until  definitely  realized.  Hence  merchandise 
should  be  valued  at  cost,  except  in  those  cases  where  the 
market  value  is  less  than  cost.  In  such  cases  the  market 
value  should  be  used  and  profits  on  sales  should  not  be 
considered  as  realized  until  the  sale  is  completed.  The 
practice  of  shipping  merchandise  on  consignment,  "on 
sale  and  approval."  or  to  branch  houses  and  including  the 
shipments  among  the  bona-fide  sales  is  fundamentally  un- 
sound. Such  shipments  should  be  credited  to  accounts 
indicating  the  nature  of  the  shipment,  and  at  the  close  of 
the  period  the  amount  of  merchandise  outstanding  with 
consignees  and  branches  should  be  added  to  the  inventory 
at  cost  (at  market  value  if  the  latter  is  lower)  less  in  some 
cases  an  allowance  for  spoilage  or  damage  in  handling. 
Only  the  goods  actually  sold  should  be  treated  as  sales. 

An  exception  to  the  rule  that  profits  should  not  be  con- 
sidered earned  until  definitely  realized  may  be  in  the  case 
of  contracts  covering  a  period  of  several  years.     If  the 


704  PRINCIPLES  OF  BUSINESS 

cost  of  the  contract  has  been  estimated  in  detail,  and  the 
actual  cost  of  the  completed  portion  does  not  exceed  its 
estimated  cost,  it  is  proper  to  consider  as  income  such 
portion  of  the  estimated  profits  as  the  portion  completed 
bears  to  the  entire  contract. 

Valuation  of  assets. — The  bases  of  valuation  of  the 
various  assets  are  discussed  at  length  in  the  chapter  on 
"Financial  Statements."  At  this  point,  however,  it  may 
be  well  to  point  out  the  important  difference  between  the 
methods  of  valuing  current  and  fixed  assets,  respectively- 
Fixed  assets  are  those  assets  which  are  necessary  to  the 
maintenance  of  the  business.  They  are  not  to  be  sold 
in  this  ordinary  course  of  business  and  therefore  all  fluc- 
tuations in  their  market  value  should  be  ignored.  They 
should  be  valued  at  cost  less  depreciation. 

Current  assets,  on  the  other  hand,  are  those  assets 
which  will  be  disposed  of  in  the  ordinary  course  of  busi- 
ness. The  market  value  should  be  the  basis  of  valuation, 
providing  that  an  enhanced  market  value  is  not  used  to 
anticipate  profits. 

Closely  allied  to  the  problem  of  valuation  is  that  of 
depreciation. 

Depreciation. — The  actual  cash  extended  and  the  ac- 
tual liabilities  incurred  in  the  operation  of  a  factory  are 
only  the  apparent  costs  of  producing  its  product.  From 
year  to  year  the  machinery  and  the  plant  itself  are  con- 
tinually wearing  out,  even  though  the  fact  may  not  be 
superficially  apparent.  A  machine  cannot  last  forever, 
and  when  it  wears  out  it  must  be  replaced,  if  the  business 
is  to  continue.  The  cost  of  replacing  the  machine  cannot 
be  charged  to  capital,  because  we  have  no  more  assets 


PRINCIPLES    OF   ACCOUNTING  705 

after  the  machine  has  been  replaced  than  we  had  origi- 
nally. On  the  other  hand,  we  cannot  very  well  charge  the 
cost  to  the  period  in  which  the  machine  is  replaced.  The 
wearing-out  of  the  old  machine  has  not  occurred  entirely 
within  that  period.  Previous  periods  have  had  the  bene- 
fit of  the  use  of  the  machine  and  proper  accounting  re- 
quires that  these  periods  be  charged  with  part  of  the 
loss  in  value  of  the  machine. 

The  wearing-out  of  the  machine  is  called  depreciation. 
It  is  difficult  for  us  to  say  of  a  machine  costing  $1,000 
that  after  one  year  of  operation  it  is  worth  only  $900. 
The  machine  is  working  as  well  as  or  even  more  efficiently 
than  when  it  was  purchased.  It  may  be  w^orth  even  more 
than  was  paid  for  it.  Yet,  from  our  past  experience  we 
are  almost  certain  that  at  the  end  of  ten  years  of  opera- 
tion the  machine  will  have  to  be  scrapped.  We  know 
that  in  the  course  of  ten  years  we  shall  have  incurred  a 
loss  of  $1,000,  but  we  cannot  decide  definitely  how  much 
of  that  loss  will  occur  each  year.  W'^e  may  estimate  the 
amount  of  depreciation  chargeable  to  each  year's  income 
upon  any  one  of  the  bases  described  later  in  this  chapter. 
At  the  end  of  each  period,  then,  w-e  will  charge  or  debit  a 
nominal  account  called  ''depreciation,"  or  "reserve  for 
depreciation,"  and  credit,  not  the  asset  which  is  depreciat- 
ing, but  an  account  called  "reserve  for  depreciation." 

The  asset  account  is  not  credited  because  the  deprecia- 
tion charge  does  not  represent  a  definite  loss  in  value, 
and  also  because  it  is  desired  to  keep  the  original  cost 
upon  the  books  as  a  matter  of  record. 

At  the  end  of  ten  years  the  machine  will  have  to  be 
replaced.     The  cost  of  the  new  machine,  up  to  $1,000, 


7o6  PRINCIPLES  OF  BUSINESS 

will  be  charged  neither  to  capital  nor  to  revenue,  but  will 
be  charged  against  the  depreciation  reserve,  which  should 
by  that  time  amount  to  $i,ooo  less  the  scrap  value  of 
the  machine,  if  it  has  an}^  scrap  value. 

Depreciation  and  repairs. — Depreciation  takes  place 
even  if  the  property  is  kept  in  repair.  As  Hatfield  says, 
"All  machinery  is  on  an  irresistible  march  to  the  junk 
heap,  and  its  progress,  while  it  may  be  delayed,  cannot 
be  prevented  by  repairs."  ^  The  rate  of  depreciation 
should  always  be  calculated  on  the  assumption  that  the 
property  will  be  kept  in  repair. 

It  would  be  possible  to  replace  a  machine,  or  plant,  part 
by  part,  so  that  at  the  end  of  the  estimated  life  of  the 
property  it  would  be  in  its  original  condition.  Replace- 
rnents  of  parts  of  machines  and  parts  of  plants  should  not 
be  charged  to  operations  but  should  be  charged  to  the 
depreciation  reserve  account.  Where  the  replacement 
cost. exceeds  the  original  cost,  such  excess  may  be  charged 
to  the  machinery  account.  If  these  renewals  and  replace- 
ments were  included  with  the  ordinary  repairs,  at  the  end 
of  the  estimated  life  of  the  asset  we  should  find  that  we 
had  a  property  account  representing  a  perfectly  good 
plant  offset  by  an  unnecessary  reserve  account.  We 
should  be  charging  revenue  twice — once  with  the  depre- 
ciation charge  and  again  with  the  cost  of  replacing  the 
asset. 

Obsolescence. — Accounting  authorities  include  ob- 
solescence as  one  of  the  causes  of  depreciation,  and  con- 
tend that  the  possibility  of  property's  becoming  obsolete 
should  be  considered  in  determining  the  amount  of  depre- 

^  Henry  R.  Hatfield,  Modern  Accounting,  p.  I2i. 


PRINCIPLES    OF   ACCOUNTING  707 

ciation.  Machinery  becomes  out-of-date  and  inefficient 
more  quickly  in  some  lines  than  others,  largely  by  rea- 
son of  the  invention  of  improved  machines.  In  the  elec- 
trical-equipment business  it  is  not  unusual  to  find  a  ma- 
chine which  could  have  lasted  ten  years  replaced  by  a 
more  up-to-date  machine  at  the  end  of  two  or  three  years. 
The  reason  for  replacing  the  machine  is  not  that  it  is 
W'Orn  out,  but  that  because  of  a  new  invention  it  has  been 
made  almost  valueless. 

If  the  charge  for  depreciation  does  not  include  an 
allowance  for  obsolescence,  and  obsolescence  does  occur 
as  in  the  illustration  above,  the  question  arises  as  to  the 
method  of  disposing  of  the  resulting  loss.  If  the  machine 
cost  $1,000  and  is  disposed  of  for  $100,  our  loss,  assum- 
ing that  a  reserve  of  $200  for  depreciation  has  been 
created,  would  be  $700  and  this  loss  would  have  to  be 
charged  off  in  the  current  year. 

Methods  of  calculating  depreciation. — The  purpose 
of  creating  a  reserve  for  depreciation  is  to  have  set  r.sids 
out  of  profits,  at  the  expiration  of  the  life  of  the  asset, 
an  amount  equal  to  its  decline  in  value.  The  amount  to 
be  set  aside  each  year  therefore  depends  upon  the  life  of 
the  asset.  It  is  impossible  to  determine  precisely  the  life 
of  any  asset,  for  its  service-life  depends  upon  a  multitude 
of  varying  factors,  such  as  the  nature  of  asset,  the  use  to 
which  it  is  put,  the  care  it  receives,  or  the  climatic  con- 
ditions of  the  locality.  To  illustrate,  a  concrete  building 
wnll  last  longer  than  a  frame  building.  In  parts  of  the 
Southwest,  boilers  have  to  be  replaced  five  times  as  often 
as  in  New  Yprk,  as  a  result  of  the  deteriorating  effect  of 
the  alkaline  water.     A  plant  operated  twenty-four  hours 


7o8  PRINCIPLES  OF  BUSINESS 

a  day  may  depreciate  more  than  three  times  as  fast  as 
a  plant  running  only  eight  hours  a  day. 

The  first  step  in  calculating  depreciation,  therefore,  is 
to  estimate  as  accurately  as  possible  the  service-life  of 
the  asset,  assuming,  of  course,  that  the  asset  will  be  kept 
in  repair.  Then  the  problem  is  to  apportion  the  loss  of 
value  over  the  life  of  the  asset.  This  may  be  done  in  one 
of  several  ways.  The  most  used  method  is  that  known  as 
the  "fixed-percentage  method,"  by  which  a  fixed  percent- 
age of  the  wearing-value  of  the  asset  is  charged  off  each 
year.  For  example,  a  machine  costs  $1,500  and  has  an 
estimated  service-life  of  ten  years,  and  a  scrap  value  of 
$300.  Each  year,  therefore,  we  depreciate  the  asset  by 
$120,  or  10  per  cent  of  $1,200.  This  method  has  the 
important  practical  advantage  of  being  simple  and  con- 
venient, and  has  usually  been  found  to  be  as  satisfactory 
and  accurate  in  practice  as  any  other  method.  It  is  not 
surprising,  then,  that  this  method  is  the  one  which  is  the 
most  generally  used,  and  that  it  is  the  method  which  is 
favored  by  the  Treasury  Department  for  the  computa- 
tion of  tax  reports,  and  by  the  Interstate  Commerce  Com- 
mission for  railway  accounting. 

A  somewhat  similar  method  is  the  so-called  sinking- 
fund  method.  A  fixed  sum  is  set  aside  annually  which 
with  interest  will  at  the  end  of  the  service-life  of  the  asset 
equal  the  amount  of  depreciation.  This  method  does 
not  require  so  large  a  deduction  as  does  the  fixed-percent- 
age method. 

The  objection  to  the  use  of  either  of  these  methods, 
however,  is  that  they  both  result  in  increasyig  the  cost  of 
operating  the  asset  each  year.     This  cost  consists  of  re- 


PRINCIPLES    OF   ACCOUNTING  709 

pairs  and  depreciation,  and  as  the  cost  of  repairs  is 
greatest  during  the  latter  part  of  the  hfe,  the  cost,  of 
operating  the  asset  obviously  increases  each  year.  To 
make  the  repairs  plus  depreciation  a  constant  quantity, 
the  amount  of  depreciation  may  be  decreased  annually. 
This  is  usually  done  by  applying  the  "weighted-year" 
method.  The  amount  of  depreciation  is  determined  for 
any  year  by  multiplying  the  total  depreciation  by  a  frac- 
tion having  as  a  numerator  the  number  of  years  the  asset 
will  last,  and  as  a  denominator  the  sum  of  the  total  years 
of  its  life/  Applying  this  method  to  the  machine  above 
mentioned — the  total  depreciation  is  $1,200,  to  be  spread 
over  ten  years ;  therefore,  the  depreciation  the  first  year 
is  10/55  of  $1,200  or  $218.18.  The  second  year  the 
depreciation  would  be  9,'55  of  $1,200,  or  $196.36,  and  the 
last  year  1/55  of  $1,200,  or  $21.82. 

The  "declining  balance  unscientific  method"  is  an  un- 
scientific attempt  to  overcome  the  objection  to  the  fixed- 
percentage  method'  and  to  decrease  the  amount  of  de- 
preciation annually.  A  fixed  percentage,  usually  decided 
arbitrarily,  is  applied  to  the  decreasing  value  of  the  asset, 
i.e.,  the  first  year  the  percentage  is  calculated  on  the  orig- 
inal cost,  the  second  year  on  the  original  cost  less  the 
first  year's  depreciation,  the  third  year  on  the  original 
cost  less  the  depreciation  for  two  years,  etc.  As  the 
percentage  is  selected  arbitrarily,  it  does  not  wipe  out 

1  The    formula    for   the    sum    of    an    arithmetical    progression    is 
N(A  +  Z) 

N  being  the  number  of  terms,  A  the  first  term  and  Z  the  last 

2 

15     (1+15) 

term.     The  sum  of  the  numbers  i  to  15  would  be =  120. 

2 
-  This  method  is  also  commonly  called  the  "straight-line"  method. 


710  PRINCIPLES  OF  BUSINESS 

the  asset  or  reduce  it  to  a  desired  residual  value.  If  the 
percentage  is  accurately  calculated  so  as  to  take  up  the 
full  amount  of  the  depreciation,  the  method  is  called  the 
"decliniog  balance  scientific."  ^ 

Some  concerns,  however,  prefer  to  increase  the  depre- 
ciation charge  each  year,  by  reversing  the  methods  al- 
ready described.  They  hold  that  the  actual  depreciation 
is  likely  to  be  small  during  the  early  years  and  that  the 
deduction  for  depreciation  should  be  commensurate. 
From  another  standpoint,  they  argue  the  practicability  of 
such  a  method  on  the  ground  that  a  new  business  cannot 
very  well  support  a  large  charge  for  depreciation  during 
its  early  years.  Other  concerns  vary  the  depreciation 
charge  approximately  with  the  size  of  the  "current  sur- 
plus. This  they  justify  on  the  ground  that  a  variation 
in  the  size  of  the  surplus  will  reflect  the  variations  in 
wear  and  tear.  They  forget,  perhaps  intentionally,  that 
depreciation  goes  on  even  when  the  machine  or  building 
is  not  in  use — and  sometimes  at  a  more  rapid  rate.  The 
advantage  of  the  method  of  calculating  depreciation 
above  described  is  that  it  tends  to  equalize  the  net  income 
available  for  dividends,  by  increasing  depreciation 
charges  in  good  years  and  decreasing  them  in  bad  years, 
and  for  this  reason  many  concerns  have  adopted  it. 

Another  method  of  accomplishing  practically  the  same 
result  is  by  applying  the  "production-unit"  method.  The 
production-unit  method  is  based  upon  the  assumption  that 

^  The  formula  for  finding  the  required  percentage  to  reduce  the 
original  value  V  to  salvage  value  S  through  a  period  of  years   (n), 

11 

X  being  the  rate  tube  calculated  is  :      X  =  i —   V   s  ."    A  salvage  value 

V 
of  $1  should  be  assumed  if  no  scrap  value  exists. 


PRINCIPLES    OF   ACCOUNTING  yii 

the  life  of  the  asset  should  be  expressed  by  the  number 
of  units  it  is  capable  of  producing.  Where  this  is  pos- 
sible, as  in  the  case  of  blast  furnaces,  the  cost  of  the 
asset  should  be  divided  by  the  estimated  capacity  in  units, 
giving  the  depreciation  charge  per  unit  produced. 

Depletion. — Depletion  is  the  decrease  or  diminution 
of  the  supply  of  a  natural  deposit.  It  is  evident  that  if 
we  purchase  a  coal  mine  containing  100,000  tons  of  coal 
for  $50,000  we  have  paid  50  cents  per  ton  for  the  coal  in 
the  mine.  If,  during  the  first  year,  we  mine  10,000  tons, 
we  must  charge  $5,000  to  the  cost  of  production  and  re- 
duce the  value  of  the  mine  by  the  same  amount.  The 
bookkeeping  entry  is  similar  to  that  for  depreciation,  an 
appropriate  nominal  account  being  debited  and  "reserve 
for  depletion"  being  credited. 

The  calculation  of  depletion  on  such  natural  deposits 
as  oil,  for  example,  is  an  exceedingly  difficult  matter.  It 
may  be  possible  to  estimate  the  rate  at  which  depletion 
is  taking  place  by  measuring  the  reduction  in  flow  or 
pressure  for  comparative  periods,  if  the  well  is  a  flowing 
one;  or  by  estimating  the  rate  at  which  the  level  is  fall- 
ing, in  the  case  of  a  well  which  must  be  pumped.  The 
difficulty  arises,  however,  that  market  prices  may  change, 
making  it  profitable  to  continue  pumping  at  a  greater  ex- 
pense than  has  been  contemplated,  or  it  may  be  seen  that 
the  installation  of  improved  pumping  machinery  would 
make  it  possible  to  continue  operations  at  a  profit,  whereas 
with  the  old  machinery  the  well  would  have  to  be  aban- 
doned and  charged  off  as  being  totally  exhausted.  •  Some 
interesting  taxation  problems  arise  out  of  such  a  situa- 
tion as  that  touched  upon  in  the  foregoing. 


712  PRINCIPLES  OF  BUSINESS 

Funds. — It  has  been  argued  that  unless  an  amount 
equal  to  the  depreciation  or  depletion  reserve  is  set  aside 
in  cash  or  marketable  securities  the  reserve  is  not  a  true 
reserve.  Nothing  could  be  farther  from  the  truth.  By 
charging  to  income  an  amount  sufficient  to  cover  depre- 
ciation we  have  retained  in  the  business  profits  that  would 
otherwise  have  been  distributed.  This  reserve  is  repre- 
sented by  any  of  the  undivided  assets  of  the  business. 

Under  certain  circumstances  it  may  be  advisable  to 
create  a  fund  equal  to  a  certain  reserve.  Thus,  if  a  cor- 
poration acts  as  its  own  insurer  it  will  charge  "income"' 
and  credit  "reserve  for  insurance"  with  the  amount  of 
premium  it  would  have  to  pay.  To  protect  itself,  it  will 
then  set  aside  a  cash  fund  equal  to  the  amount  of  reserve. 
So,  too,  if  the  purchase  of  property  has  been  financed  by 
the  issuance  of  bonds,  the  mortgage  indenture  will  often 
contain  a  provision  that  there  shall  be  set  aside  in  cash 
or  securities  a  sum  sufficient  to  pay  off  the  bonds  at  ma- 
turity. The  setting  aside  of  cash  for  a  definite  purpose 
creates  a  fund.  A  fund  may  or  may  not  have  any  con- 
nection with  a  reserve.  In  fact,  the  sinking-fund  require- 
ment in  a  mortgage  may  be  met  without  making  a  charge 
against  profits  for  depreciation  and  without  creating  a 
reserve  for  depreciation,  unless  the  mortgage  requires 
this  to  be  done  as  an  additional  protection  for  the  bond- 
holders. 

Because  of  the  careless  use  of  accounting  terms  the 
words  "fund"  and  "reserve"  have  sometimes  been  con- 
fused. In  some  balance  sheets  an  account  will  be  found 
on  the  credit  side  called  "depreciation  fund."  This 
should  be  labelled  "depreciation  reserve."     A  fund  is  an 


PRINCIPLES    OF   ACCOUNTING  713 

asset,  while  a  reserve  is  an  accountability,  and  one  may 
be  created  quite  independently  of  the  other.  Whether 
or  not  the  profits  retained  in  the  business  because  of  a 
reserve  should  be  invested  in  securities  and  set  aside  in  a 
fund  is  always  a  matter  of  financial  policy. 

•  BIBLIOGRAPHY 

Sprague,  C.  E.,  Philosophy  of  Accounts. 

Hatfield,  H.  R.,  Modern  Accounting. 

Kester,  R.  B.,  Accounting  Theory  and  Practice,  Vols.  I  and  II. 

Esquerre,  P.  I.,  Applied  Theory  of  Accounts. 

Cole,  W.  M.,  Accounts — Their  Construction  and  Interpretation^ 

Wildman,  J.  R.,  Principles  of  Accounting. 

Bennett,  R.  J.,  Corporation  Accounting. 

Saliers,   E..  Principles  of  Depreciation. 

Bentley,  Science  of  Accounts. 

Bentley,  H.  C,  Corporation  Finance  and  Accounting. 

Dickinson,  A.  L.,  Accounting  Practice  and  Procedure. 

Paton,  W.  A.,  and  Stevenson,  R.  A.,  Principles  of  Accounimg. 


ciiArxi':';  XXX 
FINANCIAL  STATEMENTS 

Old  methods  no  longer  satisfactory. — To  the  comer 
grocer  of  twenty  years  ago,  determining  his  profit  for  the 
year  was  a  simple  p"oposition.  He  took  down  from  their 
hook  his  unpaid  bills  and  added  them  up ;  that  much  he 
owed;  everything  above  that  in  the  store  was  his.  If  the 
balance  was  more  than  the  balance  of  the  year  before  he 
was  satisfied;  if  it  was  less,  he  blamed  it  on  "poor  crops." 

The  business  man  of  today  is  not  satisfied  merely  with 
knowing  that  he  has  made  a  profit;  he  wants  to  know 
where  that  profit  came  from — what  his  sales  were — what 
his  cost  of  doing  business  was — whether  the  percentage 
of  profit  this  year  was  larger  than  the  year  before — if 
not,  why  not — and  a  hundred-and-one  other  facts  about 
his  business.  He  must  have  this  information  if  he  is  to 
hold  his  own  with  his  competitors.  Indeed,  with  the 
growth  of  modern  business  and  its  increasing  complexi- 
ties, it  has  become  indispensable  that  the  executive  have 
at  his  instant  disposal  a  means  of  obtaining  accurate  in- 
formation concerning  the  progress  and  condition  of  every 
department  of  the  business. 

The  importance  of  financial  statements  in  obtaining 
and  granting  credit. — At  some  time  or  other  almost 
every  business  man  is  in  need  of  credit.  He  will  find  it 
easier  to  obtain  an  adequate  amount  of  credit  if  he  fur- 
nishes his  creditors  with  a  statement  accurately  setting 

.     714 


FINANCIAL    STATEMENTS  715 

forth  the  financial  condition  of  his  business.  In  fact, 
some  creditors  will  refuse  to  extend  any  credit  to  him  in 
the  absence  of  such  a  statement;  if  he  applies  to  his  bank 
for  a  loan  he  will  usually  be  asked  to  present  a  financial 
statement  certified  by  a  public  accountant.  Likewise, 
when  the  business  man  himself  extends  credit,  he  relies 
largely  upon  the  financial  statements  of  his  customers. 
It  is  upon  his  ability  to  interpret  these  statements — to 
create,  from  the  figures,  a  picture  of  the  actual  business — 
that  the  arnount  of  his  losses  from  bad  debts  depends. 

The  value  to  the  investor.- — The  investor  is  saved 
from  relying  on  market  tips  and  rumors  if  he  is  able  cor- 
rectly to  interpret  the  balance  sheets  and  income  state- 
ments of  the  corporation  whose  stock  or  bonds  he  owns 
or  intends  to  purchase.  It  is  from  these  same  statements 
that  he  forms  his  judgment  as  to  the  value  of  the  services 
rendered  by  his  board  of  directors.  These  are  some  of 
the  reasons  why  the  New  York  Stock  Exchange  makes 
the  furnishing  of  annual  statements  by  the  corporation 
one  of  the  requirements  for  listing  its  securities  on  the 
Exchange. 

Obligations  to  furnish  financial  statements. — De- 
tailed financial  statements  are  required  by  the  Interstate 
Commerce  Commission  of  all  railroads  engaged  in  inter- 
state commerce,  and  are  required  by  the  various  State 
commissions  of  all  insurance  and  public-utility  companies. 
The  various  Federal  and  State  tax  laws  also  require  com- 
plete statements  of  all  corporations,  individuals  or  part- 
nerships engaged  in  business,  having  net  incomes  in  ex- 
cess of  certain  specified  exemptions. 

The  balance  sheet. — The  principal  financial  statement 


yi6 


PRINCIPLES  OF  BUSINESS 


is  the  balance  sheet  or,  as  it  sometimes  is  called,  the  state- 
ment of  assets  and  liabilities/ 

The  primary  purpose  of  the  balance  sheet  is  to  set 
forth  on  one  side  the  assets,  on  the  other  side  the  liabili- 
ties, the  resulting  balance  being  the  net  worth  (some- 
times called  capital,  present  worth,  or  proprietorship)  of 
the  business. 

Importance  of  proper  construction  of  the  balance 
sheet. —  The  modern  balance  sheet  does  more  than 
merely  to  set  forth  the  total  of  the  assets  and  the  total 
of  the  liabilities,  to  show  the  net  worth.  It  segregates 
the  various  items,  to  give  a  maximum  of  information 
about  the  business. 

This  point  will  be  made  clear  by  a  comparative  study  of 
the  following  balance  sheets. 


A. 

B. 

•BALANCE  SHEET 

Machinery 

$4,000 

Notes  Payable 

$4,500 

Accounts  rece: 

ivable 

11,000 

Accounts  Payable 

14.500 

Merchandise 

6,500 

Mortgage  Payable 

3,000 

Notes  Receiva 

■ble 

7,500 

A.  B.  Net  Worth 

15,000 

Cash 

8,000 

$37,000 

$37,000 

C. 

D. 

•BALANCE  SHEET 

Real  Estate 

$11,200 

Notes  Payable 

$6,700 

Cash 

2,000 

Accounts  Payable 

12,500 

Accounts  Rec 

eivable 

3,000 

C.  D.  Net  Worth 

15,000 

Merchandise 

5, coo 

Machinery 

13,000 

$34,200 


$34,200 


^  The  term  "balance  sheet"  technically  refers  only  to  a  statement 
taken  from  books  of  double  entry.  The  term  "statement  of  assets 
and  liabilities"  refers  to  statements  prepared  from  other  records. 


FINANCIAL  STATEMENTS 


717 


Here  are  two  businesses  of  the  same  general  character. 
Judging  from  the  balance  sheet  alone,  which  one  is  de- 
serving of  the  extension  of  credit  to  the  amount  of 
$2,000?  At  hrst  glance,  there  is  little  to  choose  between 
them.  The  net  worth  of  each  business  is  $15,000.  But 
a  rearrangement  of  the  items,  so  as  to  indicate  what  lia- 
bilities must  shortly  be  paid  and  what  assets  are  avail- 
able to  meet  them,  would  show  the  balance  sheets  as 
follows : 

A.  B. 
•BALANCE  SHEET 


ASSETS 

LIABILITIES 

Current  Assets 

Current  Liabilities 

Cash 

$8,000 

Notes  Payable 

$4,500 

Accounts  Receivable 

11,000 

Accounts  Payable 

14,500 

Notes  Receivable 

7,500 

Total       Current      Lia- 

Total Current  Assets 

$26,500 

bilities 

$19,000 

Other.  Assets 

Other  Liabilities 

Merchandise 

6,500 

Mortgage  Payable 

3,000 

Machinery 

4,000 

A.  B.  Net  Worth 

15,000 

$37,000 

$37,000 

C. 

D. 

BALANCE  SHEET 

ASSETS 

LIABILITIES 

Current  Assets 

Current  Liabilities 

Cash 

$2,000 

Notes  Payable 

$6,700 

Accounts  Receivable 

3,000 

Accounts  Payable 

Total       Current      Lia- 
bilities 

12,500 

Total  Current  Assets    $5,000 

$19,200 

Other  Assets 

Aferchandise 

5,000 

C.  D.  Net  Worth 

15,000 

Machinery 

13,000 

Real  Estate 

11,200 

$34,200  $34.2'00 

Now  it  can  easily  be  seen  that  C.  D.  has  only  $5,000 


7i8  PRINCIPLES  OF  BUSINESS 

with  which  to  meet  liabiHties  of  $19,200.  Even  if  he 
were  given  a  loan  of  $2,000  on  his  note  for  sixty  days, 
there  still  would  not  be  enough  to  meet  his  immediate 
liabilities.  The  machinery  and  real  estate  cannot  be  ex- 
pected to  pay  off  the  debts,  because  to  sell  them  would 
mean  the  discontinuing  of  the  business.  The  extent  to 
which  the  merchandise  can  be  counted  on  depends  on  a 
number  of  factors,  such  as  the  nature  of  the  goods,  the 
terms  on  which  they  are  sold,  and  the  condition  of  the 
stock.  If  the  merchandise  is  mostly  finished  stock  in  a 
business  where  goods  are  sold  for  cash  or  on  short  terms, 
it  will  be  more  readily  liquidated  than  if  it  is  composed  of 
goods  in  process  which  when  finished  can  only  be  sold  on 
long  terms  of  credit.  Assuming  that  50  per  cent  of  the 
merchandise  is  readily  salable  for  cash,  we  have  only 
$7,500  in  assets  to  meet  $19,200  in  liabilities.  But  A. 
B.'s  balance  sheet  shows  current  liabilities  of  $19,000 
with  available  assets  of  $26,500,  leaving  a  working  capi- 
tal of  $7,500.  His  business,  evidently,  is  in  much  better 
condition  than  C.  D.'s  business. 

Form  of  balance  sheet. — The  arrangement  of  the 
items  on  a  balance  sheet  varies  somewhat,  the  American 
form  having  the  liabilities  on  the  right  and  the  assets  on 
the  left.  The  British  practice  is  the  direct  opposite^the 
liabilities  being  on  the  left,  and  the  assets  on  the  right. 
The  assets  are  divided  into  several  classes,  the  usual  order 
being  Fixed  Assets;  Intangible  Assets;  Current  Assets; 
Working  and  Trading  Assets;  and  Deferred  Charges  to 
Expense.  Liabilities  are  usually  grouped  as  Fixed ;  Cur- 
rent; Deferred  Credits  to  Income;  and  Capital;  though 
the  latter  is  not,   strictly  speaking,  a  liability.     Indeed 


FINANCIAL    STATEMENTS  719 

capital  is  the  ownership  in  the  business — it  is  simply  the 
difference  between  the  assets  and  liabihties.  This  con- 
ventional arrangement  of  assets  and  liabilities  is  often 
varied  by  having  the  current  assets  and  current  liabilities 
at  the  head  of  the  respective  sides  of  the  Balance  Sheet. 

The  following  is  typical  of  the  form  of  balance  sheet 
of  a  manufacturing  corporation ; 

X.    Y.    Z.    MANUFACTURING    COMPANY 

GENERAL   BALANCE    SHEET 
DECEMBER   3I,    I917 

ASSETS 

Fixed  Assets 

Land    $35,ooo 

Buildings    200,200 

Machinery  and  Equipment 142,880 

Furniture  and  Fixtures 3.515 

Good-will    100,000 

Total    Fixed    Assets $481,595 

Working  and  Trading  Assets 

Materials   and   Supplies $126,912 

Goods  in  Process 78,619 

Finished    Goods 148,640 

Total    Working    and    Trading 

Assets    354,171 

Current  Assets 

Cash    $98,808 

Accounts  Receivable 147,680 

Notes  Receivable   37.500 

Total  Current  Assets 283,988 

Deferred  Charges  to  Expense 

Insurance  Prepaid $1,868 

Interest  Prepaid 175  • 

Advertising    500 

Total     Deferred     Charges     to 
Expense   2,543 

Total  Assets $1,122,297 


720  PRINCIPLES  OF  BUSINESS 

Liabilities  and  Capital 

Fixed  Liabilities 

Mortgage   Payable $140,000 

Current  Liabilities 

Accounts   Payable $76,496 

Notes   Payable 48,800 

Dividends    Payable 35,500 

Total  Current  Liabilities 160,796 

Reserves 

For   depreciation   of : 

Fixtures    $    707 

Machinery    24,276 

Buildings    10,010 

For  Doubtful  Accounts  Receivable       2,750 
For    Income    and    Excess    Profits 
Taxes   35,ooo 

Total   Reserves 72,743 

Capital 

Common   Stock  Outstanding $300,000 

Preferred   Stock   Outstanding 250,000 

Total   Reserves 550,000 

Surplus 

Profit  and  Loss  Surplus  Jan.  1/17.  $170,931 
Profit     and     Loss     for    year     ended 
December   31,    1917 27,827 

Surplus  December  31 198,758 

Total  Liabilities  and  Capital $1,122,297 

Bank  statements. — An  unusual  form  of  financial 
statement  is  that  published  by  the  Corn  Exchange  Bank 
of  New  York.  It  has  the  great  advantage  of  being  "a. 
bank  statement  that  any  man  or  woman  can  understand." 

THE  CORN  EXCHANGE  BANK 

'  NEW  YORK 

Statement  of  July  i,  1918 

The  Bank  Owes  to  Depositors,  Payable  on  Demand..  $136,015,512.47 
A  conservative  banker  always  has  this  indebtedness 
in  mind,  and  he  arranges  his  assets  so  as  to  meet 
any  request  for  payment. 

For  this  Purpose  we  Have : 


FINANCIAL    STATEMENTS  721 

1.  Cash    $28,619,210.12 

(Gold,    Bank   Notes    and    Specie)    and   with 
legal  depositories  returnable  on  demand. 

2.  Checks  on  Other  Banks 9,829,525.49 

Payable  in  one  day. 

3.  Loans  to  Individuals  and  Corporations 13,548,786.74 

Payable  when  we  ask  for  it ;  secured  by  col- 
lateral of  greater  value  than  the  loans. 

4.  Bonds    40,970,648.25 

Of  United  States  Government    $22,804,091.06 

Of  Railroads  and  other  cor- 
porations of  first  quality 
and  easily  salable 18,166,557.19 

5.  Loans    49,856,242.31 

Payable  in   less   than   three   months   on   the 
average,  largely  secured  by  collateral. 

6.  Bonds  and  Mortgages  and  Real  Estate 1,146,375.78 

7.  Our  Sixteen  Banking  Houses 3,400,554.02 

All  located  in  New  York  City. 


Total  to  meet  Indebtedness $147,371,342.71 


8.  This  Leaves  a  Surplus  of $11,355,830.24 

Which  becomes  the  property  of  the  Stock- 
holders after  the  debts  to  the  Depositors 
are  paid. 

VALUATION   OF  ASSETS 

Balance  sheet  is  a  statement  of  opinion. — If  a  man 

owns  a  building  valued  at  $100,000,  subject  to  a  mort- 
gage of  $30,000,  his  net  worth — assuming  that  he  has  no 
other  propert}- — is  $70,000,  on  the  theory  that  if  he  were 
to  sell  the  building  and  pay  off  the  mortgage  he  would 
have  $70,000  left  in  cash.  Practically,  he  would  have 
either  more  or  less  than  $70,000,  for  it  is  almost  impos- 
sible to  determine  in  advance  of  an  actual  sale  the  cash 
value  of  an  asset.  Until  the  asset  has  actually  been  liqui- 
dated— that  is,  converted  into  cash,  any  figure  in  the  bal- 
ance sheet  is  merely  an  expression  of  opinion.  It  is  im- 
portant that  a  careful  estimate  be  made  of  the  value  of  all 
the  assets  in  the  balance  sheet.     Unless  these  estimates 


722  PRINCIPLES  OF  BUSINESS 

are  correct,  neither  too  high  nor  too  low,  the  business  man 
may  be  misled  as  to  his  financial  position. 

In  order  to  understand  a  financial  statement,  it  is  neces- 
sary to  know  what  items  are  included  under  each  head- 
ing of  the  balance  sheet  and  the  basis  upon  which  each 
has  been  evaluated. 

FIXED  ASSETS 

What  are  fixed  assets. — Fixed  assets  are  those  assets 
of  a  permanent  nature  which  the  corporation,  or  individ- 
ual, does  not  intend  to  dispose  of,  or  which  could  not  be 
disposed  of  without  seriously  interfering  with  the  opera- 
tion of  the  business. 

Real  estate. — Balance  sheets  very  often  show  the 
value  of  the  land  and  improvements  in  one  account  under 
the  name  of  Real  Estate,  Real  Property,  or  Cost  of  Prop- 
erty. While  this  method  is  legally  justified,  on  the 
ground  that  the  buildings  erected  on  land  become  a  part 
of  it,  the  accountant  prefers  to  keep  the  valuation  of  the 
land  and  that  of  the  buildings  separate.  The  reason  for 
this  is  that  in  the  case  of  buildings  depreciation  must  be 
provided  for,  while  in  the  case  of  land  no  such  provision 
is  ordinarily  required.  Land  should  ordinarily  be  valued 
at  its  original  cost,  including  the  costs  of  acquiring  title, 
such  as  title  search,  recording  fees,  and  the  like.  In  addi- 
tion, the  land  should  be  charged  with  the  cost  of  any  im- 
provements, such  as  grading  and  draining,  or  with  taxes 
levied  for  the  special  purpose  of  making  improvements 
to  the  land.  Lands  purchased  for  investment  or  for  the 
purpose  of  development  and  subsequent  sale  are  treated 
in  much  the  same  manner.  All  carrying  charges,  such  as 
taxes  and  interest,  are  added  to  the  cost  of  the  land  in 


FINANCIAL    STATEMENTS  723 

order  that  the  net  profit  from  the  sale  of  the  land  may  he 
determined.  Conservative  accounting  practice  requires 
that  a  reserve  should  be  created  for  at  least  a  part  of  such 
capitalized  charges  to  provide  against  the  failure  to  re- 
cover such  charges  upon  the  subsequent  sale  of  the  prop- 
erty. 

Improvements  upon  leased  ground. — Unless  there 
is  an  agreement  to  the  contrary,  permanent  improvemp'its 
made  upon  leased  land  pass  to  the  landlord  at  the  expira- 
tion of  the  leasehold  period.  Consequently,  the  value  of 
the  improvements  should  be  written  off  over  the  pe/iod  of 
the  lease.  Fixtures  placed  on  the  property  by  the  tenant, 
however,  may  be  removed  by  him  during  the  term  of  the 
lease,  providing  their  removal  will  not  injure  the  prop- 
erty. Hence,  not  the  entire  value  of  the  fixtures,  but 
only  the  depreciation  on  them,  need  be  written  off  during 
the  term  of  the  lease.  Moreover,  if  the  contract  pro- 
vides, as  it  often  does,  that  the  landlord  is  to  pay  the 
tenant,  at  the  expiration  of  the  period,  a  fixed  sum  for 
the  tenant's  permanent  improvements,  only  that  part  of 
the  value  of  the  improvements  which  will  not  be  recovered 
from  the  landlord  should  be  written  off. 

Valuation  of  leasehold  rights, — Where  a  leasehold 
right  is  sublet  it  is  not  customary  to  capitalize  the  value 
of  the  contract,  but  the  question  of  the  valuation  of  such 
contracts  often  arises  in  the  case  of  partnerships  when  it 
is  necessary  to  determine  the  value  of  a  partner's  interest. 

The  difference  between  the  amount  received  for  the 
leasehold  and  the  amount  paid,  therefore,  may  be  re- 
garded as  an  annuity  for  the  number  of  years  the  lease 
has  to  run,  the  present  value  of  which  may  be  determined 


724  PRINCIPLES  OF  BUSINESS 

from  any  compound-interest  table.  The  present  value  of 
any  sum  recoverable  from  the  landlord  at  the  end  of  the 
leasehold  period  may  be  determined  from  the  interest 
tables  and  added  to  the  present  value  of  the  annuity. 

Wasting  assets. — Mines,  oil  wells,  and  timber  lands 
are  "wasting  assets,"  in  that  every  dollar's  worth  of  ore, 
oil  or  timber  taken  from  the  property  reduces  the  value 
of  the  land  for  the  purpose  for  which  it  was  originally 
acquired. 

Theoretically,  the  total  mineral  or  oil  contents  of  the 
property  should  be  determined,  thereby  establishing  a  unit 
property-cost,  that  is,  the  cost  per  ton  of  coal,  or  per  gal- 
lon of  oil.  The  procedure  then  should  be,  to  reduce  the 
value  of  the  property  annually  by  an  amount  found  by 
multiplying  the  number  of  units  extracted  by  the  cost  per 
unit.  In  practice  this  method  is  not  always  followed, 
because,  except  in  the  case  of  coal  mines,  it  is  difficult 
and  in  most  cases  impossible  to  estimate  the  mineral  con- 
tents with  any  degree  of  accuracy.  Moreover,  the  crea- 
tion of  a  reserve  for  depletion  imposes  upon  the  directors 
the  alternative  of  declaring  dividends  out  of  capital  or  of 
withholding  such  a  portion  of  the  receipts  as  represents 
a  return  of  capital  and  investing  it  either  in  securities  or 
in  additional  mineral  properties.  Both  methods  are  open 
to  objections ;  investors  in  mining  property  do  not  wish 
to  be  limited  to  the  return  on  savings-bank  deposits  or 
Government  bonds,  nor  do  they  wish  to  have  their  funds 
invested  in  other  mining  properties.  In  short,  the  stock- 
holder in  a  mining  corporation  wants  all  the  proceeds 
from  the  property  of  the  corporation  to  be  returned  to 
him.     He  should  realize,  however,  that  the  returns  will 


FINANCIAL    STATEMENTS  725 

not  continue  indefinitely,  and  that  each  dividend  repre- 
sents in  part  a  return  of  his  capital  investment. 

Cost  of  buildings. — Buildings  should  be  valued  at  the 
amount  paid  for  them.  Where  a  corporation  erects  its 
own  buildings,  the  cost  of  construction  should  include  not 
only  that  of  all  labor  and  material  used  directly  upon  the 
buildings,  but  also  supervision  fees  and  the  value  of 
the  time  of  the  executive  officers  spent  in  supervising  the 
construction.  It  is  customary  also  to  include  all  inciden- 
tal and  relevant  expenses  incurred  up  to  the  time  the 
building  is  put  into  actual  use.  Thus  insurance,  taxes, 
interest  on  borrowed  money  and,  according  to  some 
authorities,  the  discount  on  securities  issued  in  the  financ- 
ing of  the  construction  would  be  added  to  the  cost. 
Where  the  erection  of  a  new  building  necessitates  the 
destruction  of  an  old  building,  the  cost  of  the  old  build- 
ing is  added  either  to  the  cost  of  the  land,  or  to  the  cost 
of  the  new  building. 

Repairs,  renewals  and  betterments. — The  only  addi- 
tions to  the  original  cost  of  the  buildings  should  represent 
betterments.  Repairs  and  renewals  should  not  be  capi- 
talized. The  distinction  between  repairs  or  renewals, 
and  improvements  or  betterments,  has  been  fully  dis- 
cussed in  the  chapter  on  "Accounting  Principles.'' 

Equipment. — The  equipment  account  should  show  the 
cost  of  those  items  wdiich  are  not  part  of  the  building  but 
which  are  essential  to  the  operation  of  the  building,  such 
as  boilers,  dynamos,  heating  plant,  or  electric  equipment. 
The  equipment  may  be  classified  under  various  headings, 
either  by  kind  or  by  operating  units. 

Machinery  account. — The  machinery  account  should 


726  PRINCIPLES  OF  BUSINESS 

not  include  any  tools  having  a  life  of  less  than  one  year, 
as  such  tools  should  be  charged  directly  to  factory  ex- 
pense. All  machinery  should  be  carried  at  cost,  and  a 
reasonable  provision  should  be  made  for  depreciation. 
The  various  methods  of  calculating  depreciation  have 
been  covered  in  the  chapter  on  "Accounting  Principles." 

Furniture  and  fixtures. — The  furniture  and  fixtures' 
account  may  be  divided  into  office  furniture  and  fixtures, 
and  show-room  furniture  and  fixtures.  The  deprecia- 
tion on  this  asset  should  be  at  high  rate.  Some  banks 
carry  this  asset  at  a  nominal  figure.  In  fact  it  is  not  an 
uncommon  practice  to  capitalize  the  amount  of  the  orig- 
inal purchase  and  to  charge  all  subsequent  purchases  to 
expense. 

Patterns,  drawings  and  dies. — There  is  a  tendency 
among  manufacturing  concerns  to  carry  all  patterns, 
drawings,  lasts  and  dies  at  cost,  without  considering 
whether  or  not  they  have  any  value  after  their  initial 
use.  The  value  to  be  placed  on  these  items  depends  upon 
the  nature  of  the  business;  if  the  business  consists  of 
"special  order"  work,  the  patterns  have  very  little  value; 
the  contrary  is  true  if  the  business  is  staple  and  the  same 
model  is  used  for  several  years.  In  the  open  market, 
however,  patterns  and  dies  have  nothing  more  than 
a  scrap  value,  and  for  this  reason  they  should  be  valued 
very  conservatively. 

Equipment  purchased  on  the  partial-payment  plan. 
— Where  equipment  is  purchased  on  a  partial-payment 
plan,  the  purchaser's  equity  during  the  rental  period  may 
be  shown  by  either  of  two  methods.  The  first  is  to  set 
up  as  an  asset  the  amount  paid  on  account  of  the  con- 


FINANCIAL    STATEMENTS 


/-/ 


tract.  This  method  does  not  show  the  hability  for  the 
unpaid  instaUments,  nor  does  it  show  the  total  cost  of 
the  equipment  upon  which  depreciation  must  be  calcu- 
lated. The  second  method  is  to  show  the  contract  in  the 
accounts  by  setting  up  as  an  asset  the  cost  of  the  equip- 
ment with  a  contra  reference  to  the  liability  in  favor  of 
the  sellers.  As  the  payments  are  made  they  are  credited 
to  the  liability  account,  which  will  finally  be  wiped  out. 

Intangible  assets. — The  assets  of  a  corporation  often 
include  certain  items  which  are  neither  tangible  property 
nor  a  direct  right  to  tangible  property.  Such  items  are 
called  intangible  assets.  The  most  common  assets  in  this 
group  are  good-will,  patents,  trade-marks,  and  copy- 
rights. 

Good-will. — Good-will  is  the  intangible  quality  of  pat- 
ronage which  attaches  to  an  established  business  and  is 
presumed  to  attach  to  it,  irrespective  of  any  change  in 
ownership.  Good-will  depends  upon  many  factors,  such 
as  location  or  reputation  and  integrity  of  the  proprietor, 
or  it  may  be  the  result  of  a  legal  or  natural  monopoly. 
From  the  accountant's  point  of  view,  good-will  should 
appear  on  the  balance  sheet  only  after  it  has  been  ac- 
quired, and  then  for  the  original  cost  only.  For  example, 
if  a  business  is  purchased,  the  difference  between  the  value 
of  the  physical  assets  and  the  purchase  price  would  be 
set  up  as  the  cost  of  good-will.  Good-will  should  not  be 
created  arbitrarily  upon  the  books  of  a  business.  An  in- 
tending purchaser  would  value  the  good-will  independ- 
ently, without  regard  to  its  value  in  the  balance  sheet, 
while  bankers  and  credit  men  usually  ignore  the  item  en- 
tirely 


728  PRINCIPLES  OF  BUSINESS 

Franchises. — Franchises  are  privileges  granted  by  the 
State.  They  may  be  classed  as  general  or  special.  Gen- 
eral franchises  are  those  which  can  be  multiplied  indefi- 
nitely, such  as  the  privilege  of  being  a  corporation ;  special 
franchises  are  those  which  cannot  be  multiplied  indefi- 
nitely, as  the  franchise  to  use  the  public  streets.  The  cost 
of  acquiring  a  general  franchise  is  an  expense  which  is 
incident  to  the  organization  of  every  corporation  and  is 
grouped  with  other  organization  expenses,  the  disposition 
of  which  is  discussed  later. 

The  cost  of  acquiring  a  special  franchise  either  from 
the  State  or  by  purchase  may  be  capitalized  and  carried 
as  an  asset.  The  arbitrary  placing  of  a  value  upon  fran- 
chises is  open  to  the  same  objections  as  the  arbitrary  valu- 
ing of  good-will — that  the  value  of  the  franchise  depends 
upon  the  earning  power  of  the  business  and  not  upon  the 
figure  at  which  it  appears  in  the  books. 

Patents,  trade-marks  and  copyrights. — A  patent  is  a 
grant  made  by  the  Government  to  an  inventor,  conveying 
and  securing  to  him  the  exclusive  right  to  make  and  sell 
his  invention  for  a  period  of  seventeen  years.  The  grant 
may  be  rene'wed  only  by  special  act  of  Ccnigress. 

A  trade-mark  is  a  grant  made  by  the  Govefntnent  re- 
serving to  the  holder  of  the  grant  the  right  to  usd  a  cer- 
tai-n  label,  design,  slogan  or  device  as  his  exclusive  trade- 
mark.    This  grant  runs  for  thirty  years. 

A  copyright  is  a  grant  conveying  the  exclusive  privi- 
lege of  printing,  publishing  or  vending  copies  of  certain 
artistic,  musical  or  literary  productions,  for  a  period  of 
twenty-eight  years,  and  is  renewable  under  certain  con- 
ditions for  a  like  period. 


FINANCIAL    STATEMENTS  729 

A  patent  purchased  from  an  inventor  or  from  a  former 
owner  should  be  valued  at  the  purchase  price.  If  the  in- 
vention is  made  by  employees  of  the  concern  it  is  proper 
to  charge  the  patent  with  the  entire  cost  of  the  experi- 
ments and  with  all  fees  paid  to  obtain  the  patent.  In 
either  case  the  value  should  be  entirely  amortized  during 
the  legal  life  of  the  patent.  A  better  plan  would  be  to 
write  off  the  patent  over  a  period  less  than  its  legal  life, 
because  there  is  the  constant  danger  of  its  being  rendered 
valueless  by  new  inventions. 

A  trade-mark  may  have  a  value  after  its  legal  life  has 
expired,  but  such  value  is  in  the  nature  of  good-will  and 
should  be  shown  as  such. 

Copyrights  should  be  written  off  over  as  short  a  period 
as  possible.  Unless  a  high  price  has  been  paid  for  the 
copyright,  it  should  be  considered  as  an  expense  of  the 
first  edition  of  the  work. 

Treasury  stock. — Treasury  stock  is  that  stock  of  a 
corporation  which,  having  once  been  issued  for  value,  is 
subsequently  accjuired  by  purchase,  donation  or  exchange. 
It  should  be  distinguished  from  unissued  stock,  which  is 
not  an  asset.  Treasury  stock  is  an  asset  in  that  it  repre- 
sents value  received,  but  as'  long  as  it  is  held  by  the  cor- 
poration it  does  not  receive  dividends  nor  can  it  be  voted 
at  the  meetings  of  the  corporation. 

Creating  treasury  stock  by  donation  is  a  method  used 
to  avoid  the  restrictions  against  the  issuance  of  stock  be- 
low par. 

The   entire   stock   is   usually   issued   in   exchange    for" 
property  or  services,  the  recipients  of  the  stock  then  do- 
nating a  portion  of  the  stock  back  to  the  corporation. 


730  PRINCIPLES  OF  BUSINESS 

This  stock  is  then  unrestricted  as  to  the  price  at  which  it 
may  be  sold.  The  donated  or  treasury  stock  is  usually 
entered  at  par,  a  "donation''  or  "donation  reserve"  ac- 
count being  credited.  Any  loss  on  the  sale  of  the  treas- 
ury stock  is  charged  against  the  donation  account.  While 
the  theoretical  disposition  of  the  donation  account  would 
be  to  apply  it  to  reducing  the  valuation  of  the  assets  for 
which  the  stock  was  originally  issued,  this  is  seldom  done, 
because  such  a  procedure  would  be  an  admission  on  the 
part  of  the  directors  that  the  assets  had  been  overvalued. 
The  usual  procedure  is  to  hold  the  reserve  account  open 
until  the  corporation  "is  on  its  feet"  and  then  transfer 
it  to  the  surplus  account. 

CURRENT   ASSETS 

What  are  current  assets. — Current  assets  are  those 
assets  which  are  available  for  the  discharge  of  current 
liabilities — such  assets  as  cash  on  hand  and  in  banks,, 
notes  receivable,  accounts  receivable,  and  the  like. 

Cash  in  banks. — "Cash  in  banks"  should  include  only 
undrawn  deposits  in  solvent  banks,  or  with  other  deposi- 
taries, subject  to  check.  In  determining  the  balance,  all 
checks  issued  against  the  deposits  should  be  deducted,  re- 
gardless of  whether  or  not  all  of  these  checks  have  been 
deducted  by  the  bank.  If  more  than  the  bank  balance  has 
been  withdrawn  the  overdraft  should  be  shown  as  a  lia- 
bihty. 

Cash  on  hand. — "Cash  on  hand"  should  not  include 
'"I.O.U's,"'  post-dated  checks,  balances  in  the  hands  of 
agents  for  expenses,  or  memoranda  of  money  advanced. 
Actual  cash  in  the  hands  of  branch  offices  or  stores  that  is 


FINANCIAL    STATEMENTS  731 

not  tied  up  in  any  manner  may  be  included  as  cash  on 
hand. 

Notes  receivable. — The  item  "Notes  Receivable" 
should  include  negotiable  promissory  notes  or  accepted 
drafts  received  from  customers  for  goods  sold  which 
have  not  been  discounted  or  assigned.  The  term  "Notes 
Receivable''  is  used  instead  of  "Bills  Receivable,"  to  avoid 
confusion  with  bills  received  for  merchandise  purchased. 
Where  notes  receivable  have  been  discounted,  opinions 
differ  as  to  how  the  contingent  liability  as  an  endorser 
should  be  shown.  Some  authorities  hold  that  the  total 
amount  of  notes  received  should  be  shown  as  an  asset 
until  the  note  is  paid  by  the  maker,  and  that  an  offsetting 
liability  should  be  created  for -the  amount  of  notes  dis- 
counted and  as  yet  unpaid.  The  majority  of  credit  men, 
however,  prefer  that  only  the  amount  on  hand  be  shown 
as  an  asset,  and  that  the  contingent  liability  on  notes  dis- 
counted be  shown  in  a  footnote. 

Where  notes  are  received  from  officers,  directors,  part- 
ners or  others  interested  in  the  business  they  should  not 
be  shown  in  "Notes  Receivable"  but  in  a  separate  account. 
They  may  be  legitimate  assets  but,  in  order  that  the  bal- 
ance sheet  ma}^  give  the  maximum  of  information,  all 
transactions  incidental  to  and  not  forming  a  necessary 
part  of  the  business  should  be  shown  in  an  account  sepa- 
rate from  that  which  shows  the  transactions  of  the  busi- 
ness proper. 

Where  one  company  advances  either  cash  or  merchan- 
dise to  a  subsidiary  company  on  its  note,  such  a  note 
should  not  be  included  in  "Notes  Receivable."  Such  ad- 
vances often  represent  an  investment  in  the  subsidiary 


'J12  PRINCIPLES  OF  BUSINESS 

company  and,  since  "Notes  Receivable"  is  considered  a 
quick  asset,  it  would  be  misleading  to  group  such  notes 
with  those  received  from  customers  in  the  ordinary  course 
of  business. 

Notes  receivable  are  not  always  worth  their  face  value. 
Where  notes  are  accepted  in  settlement  of  overdue 
accounts  they  should  not  be  appraised  as  "good"'  for  the 
full  amount.  Where  goods  are  sold  almost  entirely  upon 
open  account  a  large  amount  of  notes  receivable  would  be 
looked  upon  with  suspicion.  In  other  lines  of  business, 
however,  nearly  all  merchandise  is  sold  for  notes  and  the 
item  "Notes  Receivable''  could  well  be  large.  Moreover, 
with  the  provisions  for  rediscounting  under  the  Federal 
Reserve  system  it  is  expected  that  notes  or  trade  accept- 
ances will  take  the  place  of  the  open  account,  and  make 
large  balances  of  "notes  receivable"  more  highly  valued. 

Accounts  receivable. — "Accounts  Receivable''  should 
include  only  the  balance  of  charges  against  debtors,  usu- 
ally for  merchandise  sold  and  delivered.  Advances  to 
salesmen,  loans  to  ofificers  or  employees,  and  overdrafts 
of  partners  should  be  shown  separately. 

Accounts  receivable  from  subsidiary  companies  should 
be  shown  separately,  for  the  same  reasons  that  were  given 
in  the  case  of  the  notes. 

The  accounts  receivable  form  one  of  the  most  impor- 
tant assets  and  are  largely  relied  upon  to  meet  the  current 
liabilities.  The  total  amount  of  accounts  receivable 
should  be  in  fair  proportion  to  the  sales.  If  a  concern 
does  a  business  of  $100,000  a  month  on  a  maximum 
credit  period  of  60  days,  accounts  receivable  to  the  extent 
of    $350,000    would    be    disproportionately    large,    and 


FINANCIAL   STATEMENTS  7^2, 

would  indicate  that  old  or  doubtful  balances  were  being 
carried  forward,  or  that  ordinary  collections  were  not 
being  made  promptly. 

Reserves  should  be  created  for  all  doubtful  and  dis- 
puted accounts  and  also  for  any  deductions  that  the  ac- 
counts are  subject  to,  such  as  allowances,  trade  discounts, 
or  claims  for  defective  goods. 

Investments  in  stocks  and  bonds. — Only  temporary 
investments  of  surplus  funds  in  securities  should  be  in- 
cluded in  current  assets.  Investments  of  reserve  funds 
should  be  shown  as  funds  ear-marked  so  as  to  designate 
their  purposes.  Investments  for  the  purpose  of  control- 
ling the  activities  of  other  organizations  should  be  dis- 
tinctly marked  as  investments  in  controlled  organizations. 
The  value  of  such  securities  can  be  determined  only  by 
a  careful  study  of  the  balance  sheet  of  the  controlled 
company. 

WORKING  AND   TRADING  ASSETS 

Inventories. — The  iriventories  of  unsold  merchandise 
and  supplies  are  usually  grouped  in  the  balance  sheet 
under  the  head  of  "Working  and  Trading  Assets."  In- 
ventories may  be  divided  into  raw  material,  goods  in 
process,  finished  goods,  and  supplies ;  and  the  separate 
divisions  should  be  shown  upon  the  balance  sheet.  The 
inventory  should  wherever  possible  be  the  result  of  an 
actual  physical  inventory,  although  if  accurate  stock 
records  are  kept  and  frequently  compared  with  the  physi- 
cal stock,  the  book  figures  may  be  accepted.    • 

Valuation  of  merchandise. — As  a  general  rule,  mer- 
chandise should  be  valued  at  cost  or  market  price,  which- 


734  PRINCIPLES  OF  BUSINESS 

ever  is  the  lower.  Where  the  market  price  is  higher  than 
cost,  the  cost  basis  should  be  used.  Where  the  market 
price  is  lower  than  cost  a  known  loss  exists,  which  should 
be  taken  upon  the  books,  but  where  the  market  price  is 
higher  it  is  poor  business  policy  to  take  up  an  unrealized 
profit  which  may  in  fact  never  be  realized.  Moreover, 
only  salable  merchandise  should  be  valued  at  cost.  Mer- 
chandise which  is  shop-worn  or  out-of-date  should  be 
carried  at  its  realizable  value. 

By  cost  is  meant  the  cost  at  the  store,  factory,  or  ware- 
house. It  is  proper  to  add  to  the  original  purchase  price 
the  expense  of  bringing  the  merchandise  to  the  store- 
house, including  freight  and  cartage,  warehouse  and 
terminal  charges,  and,  in  the  case  of  imported  goods, 
marine  insurance  and  duty. 

Work  in  process  should  be  valued  at  the  cost  of  the  raw 
material  and  direct  labor  entering  into  it,  plus  a  propor- 
tion of  the  manufacturing  overhead.  Where  an  ade- 
quate cost  system  is  maintained  the  valuation  of  goods 
in  process  on  the  above  basis  is  not  difficult. 

Finished  goods  should  be  valued  at  the  cost  of  manu- 
facturing. Some  merchants  value  their  merchandise 
when  ready  for  sale  at  the  selling  price.  Unless  the  goods 
have  actually  been  sold  so  that  title  has  passed,  this 
method  is  obviously  wrong.  It  takes  in  the  profit  on  the 
sale  before  it  is  completed  without  taking  in  any  of  the 
expenses  of  making  the  sale.  In  some  cases,  where  the 
goods  are  manufactured  under  a  contract  which  passes 
title  to  the  yendee  as  soon  as  the  article  is  completed,  the 
manufacturer  would  be  justified  in  valuing  his  finished 
goods  at  sales  prices. 


FINANCIAL    STATEMENTS  735 

DEFERRED  CHARGES  TO  EXPENSE 

What  are  deferred  charges. — Where  Habilities  have 
been  incurred  or  cash  paid  for  items  of  expense  the  bene- 
fit or  a  part  of  the  benefit  of  which  will  be  enjoyed  in  a 
succeeding  period  or  periods,  the  portion  of  the  expense 
applicable  to  the  later  period  is  shown  upon  the  balance 
sheet  as  a  deferred  charge  to  expense.  These  assets  are 
sometimes  called  prepaid  expenses,  or  deferred  assets. 

Organization  expenses. — The  expenses  incident  to 
the  organization  of  a  corporation,  such  as  incorporation 
fees  or  taxes,  and  legal  and  accounting  fees,  are  an  illus- 
tration of  the  type  of  asset  known  as  "organization  ex- 
penses." These  expenses  are  incurred  only  once  during 
the  life  of  the  corporation,  but  the  benefits  continue  as 
long  as  the  corporation  exists.  Conservative  accountants 
and  business  men  show  the  organization  expenses  at  the 
end  of  the  first  year  as  a  deferred  charge,  but  write  them 
off  within  the  following  three  to  five  years. 

Prepaid  expenses. — Other  examples  of  deferred 
assets  are  those  expenses  which  are  ordinarily  paid  in  ad- 
vance, such  as  rent,  insurance  and  interest.  Any  portion 
of  such  expenses  which  applies  to  succeeding  periods  may 
properly  be  capitalized.  For  example,  if  a  concern,  in 
advertising  its  products,  spends  considerable  sums  of 
money  the  benefits  of  which  are  not  received  in  the  year 
in  which  the  expenses  are  incurred,  it  is  justified  in  treat- 
ing the  cost  of  the  advertising  campaign  as  an  asset  for 
a  limited  period.  The  capitalization  of  expenditures  of 
this  kind  should  be  for  a  short  period.  In  unusual  cases 
it  may  be  permissible  to  carry  these  expenditures  as  capi- 
tal assets  for  a  longer  period,  but  the  practice  of  carrying 


736  PRINCIPLES  OF  BUSINESS 

them  permanently,  as  a  form  of  good-will,  is  not  to  be 
commended.  It  is  true  that  if  a  national  advertising 
campaign  is  successful  it  results  in  the  creation  of  good- 
will, but,  as  stated  before,  good-will  (except  in  the  case 
of  actual  purchase)  is  indicated  by  increased  income  and 
not  by  an  item  in  the  balance  sheet.  As  a  general  rule 
it  may  be  said  that  expenses  should  not  be  capitalized  un- 
less an  immediate  and  definite  benefit  w'ill  accrue  to  the 
following  periods. 

Discounts  on  bonds. — The  sale  of  bonds  at  a  dis- 
count is  a  method  of  giving  the  purchaser  a  higher  rate 
of  interest  than  that  specified  in  the  bond.  The  discount, 
or  difference  between  the  face  amount  and  the  amount 
'actually  received,  is  a  prepayment  of  the  additional  inter- 
est. The  discount  should  be  set  up  as  an  asset  and 
written  off  ratably  over  the  life  of  the  bonds.  The  prac- 
tice of  adding  to  the  cost  of  construction  the  discount  on 
bonds  issued  to  finance  the  construction  is  not  regarded 
as  being  in  line  with  a  sound  financial  policy.  The  cost 
of  construction  should  not  be  affected  by  the  method  by 
which  the  construction  is  financed. 

ANALYSIS  OF  LIABILITIES 

Liabilities  and  capital. — On  the  right  side  of  the  bal- 
ance sheet  are  found  the  liabilities  and  capital.  A  liability 
is  a  claim  against  a  debtor  which  gives  the  creditor  a  right 
of  action  at  law.  The  capital  account  represents  not  a 
liability  but  an  accountability — the  accountability  of  the 
business  to  its  owners.  Liabilities  are  usually  classed  as 
fixed  liabilities,  current  liabilities,  and  deferred  liabilities 
or  deferred  credits  to  income. 


FINANCIAL    STATEMENTS  737 

Fixed  liabilities. — "Fixed  liabilities"  should  include 
those  liabilities  which  are  not  to  be  liquidated  in  the  or- 
dinary course  of  business.  These  are  sometimes  called 
capital  liabihties,  because  the  proceeds  of  such  liabilities 
are  usually  invested  in  fixed  or  capital  assets.  If  there 
are  various  mortgages  and  issues  of  bonds,  they  should  be 
shown  separately,  giving  the  date  of  maturity,  the  rate 
of  interest,  and  the  property  pledged  as  security  for  each 
issue.  Chattel  mortgages,  which  are  mortgages  on  per- 
sonal property,  may  be  shown  either  on  the  balance  sheet 
proper  or  in  a  footnote.  In  most  cases,  chattel  mortgages 
are  given  as  additional  security  for  merchandise  pur- 
chased on  credit,  and  their  omission  from  the  balance 
sheets  places  subsequent  creditors  at  a  disadvantage. 

Current  liabilities. — "Current  Liabilities"  includes  all 
liabilities  which  are  to  be  met  in  the  ordinary  course 
of  business,  usually  within  a  period  of  one  year.  Notes 
payable  should  be  classified  as  notes  to  trade-creditors, 
notes  to  banks,  notes  to  officers,  and  the  like.  All  interest 
should  be  accrued  up  to  the  date  of  the  balance  sheet. 
Notes  to  trade-creditors  -or  "accounts  payable"  will  in- 
clude all  amounts  due  for  merchandise  or  supplies  pur- 
chased and  for  other  expenses  incurred  in  the  ordinary 
course  of  business.  Expenses  accrued  should  include  all 
amounts  due  and  unpaid  at  the  date  of  the  balance  sheet 
for  salaries,  wages,  telephone,  light,  and  other  similar 
items.  Taxes  accrued  up  to  the  date  of  the  balance  sheet 
should  be  shown  as  a  separate  item,  and  should  include 
the  estimated  amount  of  income  and  other  Federal  taxes 
accrued.  Dividends  are  a  liability  only  when  declared  by 
the  directors.     Unpaid  dividends  on  cumulative  preferred 


738  PRINCIPLES  OF  BUSINESS 

stock  are  not  a  liability,  but  for  the  protection  of  possible 
investors  in  the  common  stock  the  amount  of  dividends 
in  arrears  should  be  stated  in  a  footnote  attached  to  the 
balance  sheet.  The  contingent  liability  on  notes  receiv- 
able discounted  has  been  discussed  in  connection  with 
notes  receivable.  A  similar  contingent  liability  exists  in 
the  case  of  the  debt  or  rental  of  a  subsidiary  guaranteed 
by  a  parent  company.  It  is  customary  to  show  the  con- 
tingent assets  and  liabilities  not  in  the  balance  sheet 
proper,  but  in  a  footnote  attached  to  the  balance  sheet. 

Deferred  credits  to  income. — Where  income  is  not 
applicable  to  the  year  in  which  it  is  received,  such  as  rent 
received  in  advance  or  premium  received  on  bonds  sold, 
the  crediting  to  income  should  be  deferred  until  such 
time  as  it  is  earned,  and  the  amount  so  received  should  be 
shown  in  the  balance  sheet  as  a  deferred  credit  to  income. 

Capital  and  surplus. — The  difference  between  the 
assets  and  liabilities  of  the  business  constitutes  the  capital 
of  the  business.  In  the  balance  sheet  of  a  sole  proprietor 
this  is  stated  as  capital  or  present  worth ;  in  the  case  of  a 
corporation  it  is  separated  into  capital  stock  and  surplus, 
the  former  representing  the  original  capital  contributed, 
the  latter  the  subsequent  earnings  reinvested  in  the  busi- 
ness. The  laws  of  most  States  prohibit  the  payment  of 
dividends  out  of  capital.  Although  the  surplus  account 
theoretically  represents  the  profits  from  the  business 
operations  it  may  include  a  surplus  contributed  at  the 
time  of  organization  or  reorganization,  or  a  surplus 
created  by  revaluation  of  assets  or  by  other  means. ^ 

While   surplus  however  created  may  legally  be   dis^ 

^  See  chapter  on  "Financing." 


FINANCIAL    STATEMENTS  739 

tributed,  the  stockholder  should  be  notified  of  the  source 
of  such  a  dividend  in  order  that  he  may  not  be  led  to 
believe  that  the  dividend  has  been  paid  out  of  current 
earnings. 

It  is  only  too  common  to  find  in  published  balance 
sheets  an  item  "Surplus  and  Reserves."  Reserves  to  pro- 
vide for  a  decrease  in  the  value  of  assets,  such  as  reserves 
for  depreciation  or  bad  debts,  are  not  a  part  of  the  sur- 
plus and  should  be  shown  separately.  To  prevent  con- 
fusion with  the  surplus  account  the  reserves  are  often 
deducted  directly  from  the  value  of  the  asset.  Thus  the 
machinery  account  would  be  shown  in  the  balance  sheet 
as  follows : 

Machinery    $ioo,oo(/ 

Less  reserve  for  depreciation 10,000 

Net   value    $90,000 

The  combining  of  surplus  and  reserve  accounts  is  often 
used  to  cover  losses  in  operation  or  failure  to  provide  for 
depreciation. 

Interpretation  of  balance  sheet. — As  shown  by  the 
balance  sheets  of  A.B.  and  CD.,  in  the  early  part  of  this 
chapter,  the  amount  of  capital  possessed  by  a  business  is 
not  the  most  important  indication  of  its  condition.  A 
concern  may  have  an  excess  of  assets  over  liabilities  and 
yet  be  forced  into  a  receivership,  for  it  may  be  unable  to 
meet  its  maturing  liabilities.  The  ratio  between  current 
assets  and  current  liabilities  is  therefore  important.  No 
standard  ratio  can  be  fixed,  although  bankers  like  to  have 
it  at  least  2  to  i  and  preferably  as  high  as  4  to  i.  Special 
circumstances  may  prevent  the  maintaining  of  this  ratio 
and  these  circumstances  must  be  considered  before  pass- 


740  PRINCIPLES  OF  BUSINESS 

ing  judgment  upon  the  statement.  For  example,  certain 
businesses  are  seasonal  and  a  large  stock  of  merchandise 
must  be  accumulated  to  meet  the  demands  of  the  trade. 
Thus,  in  the  fur  manufacturing  business,  few  if  any  state- 
ments prepared  as  of  July  i  would  show  a  ratio  as  high 
as  2  to  I.  In  rising  markets  the  tendency  of  manufac- 
turers is  to  invest  surplus  funds  in  raw  materials  in  order 
to  take  advantage  of  the  increase  in  price.  Merchandise 
inventories  are  not  usually  included  among  the  current 
assets,  but  in  the  inventory.  From  the  amount  of  raw 
material,  work  in  process,  and  finished  goods  shown  by 
the  inventory,  we  can  determine  the  extent  to  which  the 
merchandise  may  be  relied  upon  to  meet  the  liabilities. 
Finished  goods  in  a  staple  line  are  of  almost  equal  value 
with  accounts  receivable,  while  goods  in  process  have  very 
little  value  until  completed.  The  inventory  should  also 
be  viewed  in  connection  with  the  amount  of  sales.  Thus 
an  inventory  of  $500,000  and  annual  sales  of  $1,000,000 
would  indicate  either  that  the  inventory  had  been  inflated 
or  that  out-of-date  and  unsalable  stock  had  been  in- 
cluded. Before  forming  a  conclusion  that  the  inventory 
is  too  large,  the  following  factors  should  be  considered 
— length  of  the  manufacturing  process,  composition  of 
the  inventory,  trade  conditions,  and  unfilled  orders.  It 
is  evident  that  a  concern  whose  manufacturing  process 
takes  two  months  will  require  a  larger  inventory  in  pro- 
portion to  its  sales  than  one  in  which  the  process  takes 
two  weeks.  Likewise,  a  large  inventory  of  raw  materials 
may  be  justified  because  of  an  exceptional  opportunity  to 
purchase  at  an  attractive  price  or  because  of  rising  mar- 
kets.    A  heavy  inventory  of  finished  goods  may  be  justi- 


FINANCIAL    STATEMENTS  741 

fied  in  a  seasonal  business,  or  in  cases  where  there  is  a 
large  number  of  unfilled  orders  on  hand. 

Comparative  balance  sheets. — As  balance  sheets  are 
more  frequently  published  than  are  income  statements,  it 
frequently  is  necessary  to  judge  of  the  progress  of  a  busi- 
ness by  comparing  two  successive  balance  sheets.  The 
first  indication  of  a  profit  is  an  increase  in  the  surplus 
account,  but,  as  is  shown  by  the  following  illustration,  an 
increase  in  surplus  does  not  always  represent  earnings. 

A.  B.  COMPANY 

COMPARATIVE  BALANCE   SHEETS 

Assets                                                   1916  1917 

Cash   $  27,300  $     18,000 

Accounts  Receivable 165,700  146,300 

Stock    97,000  497,000 

Real    Estate 224,000  251,700 

Good-will    150,000  150,000 

Deficit    50,000  

Total    Assets $714,000  $1,063,000 

Liabilities  and  Capital 

Notes   Payable $134,000  $    166,000 

Accounts    Payable 80,000  230,000 

Surplus    167,000 

Capital    500,000  500,000 

Total   Liabilities   and    Capital $714,000  $1,063,060 

Analysis. — The  concern  has  changed  a  deficit  of  $50,- 
000  into  a  surplus  of  $1^7,000  and  has  presumably  earned 
$217,000.  As  a  matter  of  fact,  the  financial  position  has 
become  worse,  instead  of  having  been  improved.  The 
current  assets  have  decreased  almost  $30,000.  The  real 
estate  has  increased  nearly  $28,000,  which  increase 
accounts  for  the  most  of  the  decrease  in  the  current  assets. 
The  merchandise  inventory  has  increased  $400,000, 
$182,000  of  which  is  accounted  for  by  an  increase  in  cur- 


742  PRINCIPLES  OF  BUSINESS 

rent  liabilities.  The  remaining  $218,000  of  the  increase 
in  merchandise  inventory  represents  the  profits  supposed 
to  have  been  earned.  In  the  absence  of  any  other  evi- 
dence we  are  forced  to  the  conclusion  that  the  merchan- 
dise inventory  has  been  greatly  overvalued,  and  that  a 
large  part  of  the  supposed  profit  does  not  exist. 

THE  INCOME  STATEMENT 

Value  of  the  income  statement. — While  we  have  seen 
that  considerable  information  as  to  the  condition  of  a 
business  may  be  obtained  by  a  study  of  its  balance  sheet, 
and  that  still  more  knowledge  may  be  had  from  the  state- 
ments of  several  successive  years,  still  we  do  not  know 
the  causes  of  the  changes  in  the  financial  position.  The 
"Income  Statement"  or,  more  fully,  the  "Statement  of 
Income,  Profit  and  Loss"  furnishes  us  the  needed  infor- 
mation ;  it  explains  in  detail  the  transactions  of  the  fiscal 
period,  and  from  it  we  can  judge  of  the  efficiency  and 
progress  of  the  business. 

X.  Y.  Z.  MANUFACTURING  COMPANY 

•  STATEMENT  OF   INCOME,  PROFIT,  AND   LOSS 

For  the  year  ended  December  31,  1917 

Sales   i $1,396,526 

Cost  of  Goods  Sold 

Materials  and   Supplies $  494,964 

Direct  Labor.  .  . : 315,127 

Indirect    Labor 146,467 

Heat,  Light  and  Power 12,165 

Alterations,  Repairs  and  Renewals 1,276 

Depreciation   of   Machinery 14,288 

Freight   and   Cartage 2,967 

Decrease  in  inventory  of  raw  material  and 

goods  in  process 40,396 

Total  Cost  of  Manufacture $1,027,650 

Add — Decrease  in  inventory  finished  goods,.  41,128 


FINANCIAL    STATEMENTS  743 

Cost  of  Goods  Sold 1,068,778 

Gross  Profit  on  Sales $327,745 

Selling  Expenses 

Salaries  of  Salesmen $34,007 

Commissions 45J26 

Traveling    Expenses 6.619 

Advertising   8,109 

Total  Selling  Expenses 93.86l 

Selling  Profit    $233,884 

Administrative  Expenses 

Salaries  of  Officers  and  Clerks $78,629 

Stationery  and  Printing. 1,490 

Telephone  and  Telegraph 776 

Postage   Expense 995 

Depreciation   of    Office    Equipment 351 

Provision  for  Doubtful  Accounts 3.785 

General    Expense..                 15,960 

Total  Administrative  Expenses 101,986 

Net  Profit  on  Sales — Income  from  Operations $131,898 

Other  Income 

Interest  on  Notes  Receivable $311 

Interest  on  Bank  Balances 445 

Cash  Discount  on  Purchases 3,739 

Total  Other  Income 4.495 

Total  Income    $136,393 

Deductions  from  Income  • 

Interest  on  Notes  Payable $2,289 

Cash  Discount  on  Sales 24,945 

Depreciation   of   Building 5,004 

Taxes   on   Building 523 

Insurance    5-305 

Total  Deductions  from  Income 38,066 

Net  Income — Profit  and  Loss  for  the  period $98,327 

Distribution  of  Net  Income 

Reserved  for  Taxes $35,opo 

Preferred    Dividend 17,500 

Common   Dividends 18,000 

Total  Income  Distributed 70,500 

Surplus  for  Period $  27,82?" 


744  PRINCIPLES  OF  BUSINESS 

Gross  income. — The  first  item  appearing  in  any  income 
statement  should  be  the  primary  gross  income,  which,  in 
the  case  of  manufacturing  and  mercantile  businesses,  is 
"Gross  Sales."  As  explained  in  the  chapter  on  ''Prin- 
ciples of  Accounting,"  approval  sales  or  merchandise 
shipped  on  consignment  should  not  be  included  with  the 
completed  sales.  If  such  transactions  have  been  entered 
upon  the  books  as  sales,  the  amount  should  be  deducted 
from  the  total  of  the  sales,  as  well  as  from  the  total  of 
accounts  receivable,  and  the  cost  of  the  merchandise  in 
the  'hands  of  customers  should  be  shown  as  part  of  the 
inventory.  Where  freight,  parcel  post,  insurance  or  other 
charges  are  prepaid  by  the  seller  and  then  added  to  the 
invoice,  such  charges  should  not  be  credited  to  the  sales 
account.  Crediting  the  sales  account  with  these  results 
in  an  overstatement  of  sales  and  an  understatement  of  ex- 
penses. 

It  is  advisable  to  show  the  amount  of  cash  sales  and 
sales  on  credit  separately.  The  amount  of  sales  on  credit, 
taken  in  conjunction  with  the  terms  of  credit,  is  an  indica- 
tion of  the  proper  amount  of  accounts  receivable.  Thus 
if  the  annual  business  is  $120,000  and  the  terms  of  credit 
60  days,  the  outstanding  accounts  should  not  exceed  $20,- 
000.  If  the  accounts  are  considerably  in  excess  of  this, 
they  will  include  old  and  worthless  balances,  unless,  per- 
haps, the  business  is  seasonal  and  the  statement  is  taken 
at  the  close  of  the  season. 

Trade  discounts  are  very  often  deducted  upon  the  face 
of  the  invoice  and  the  net  amount  entered  in  the  sales 
account.  If,  for  any  reason,  it  is  desired  to  keep  a  record 
of  the  trade  discounts  allowed,  the  sales  may  be  entered 


FINANCIAL   STATEMENTS  745 

"gross"  and  the  trade  discount  shown  as  a  deduction  from 
sales. 

Sales  returns  should  be  shown  as  a  separate  item.  The 
practice  of  returning  goods  is  one  of  the  evils  of  modern 
business  which  may  be  partly  controlled  if  the  manage- 
ment is  properly  informed.  Allowances  made  to  cus- 
tomers for  defective  merchandise,  for  breakage,  or  for 
other  causes,  as  distinguished  from  mere  price  correc- 
tions, should  be  shown  as  a  deduction  from  sales. 

The  amount  of  the  gross  sales,  less  that  of  sales  returns 
and  allowances,  is  called  the  "net  sales,"  and  is  the  basis 
of  all  percentage  calculations  based  upon  sales.  The 
relation  between  the  amount  of  sales  and  the  amount  of 
the  final  inventory  has  already  been  discussed,  in  con- 
nection with  the  interpretation  of  the  balance  sheet,  as 
have  the  factors  that  should  be  considered  before  decid- 
ing whether  or  not  the  amount  of  the  inventory  figures 
is  too  large. 

Unusual  transactions,  such  as  sale  of  land  holdings, 
patent  rights,  and  the  like,  should  not  be  confused  with 
the  ordinary  business  transactions.  They  should  be 
shown  as  "other  income"  under  sufficiently  descriptive 
headtngs. 

Cost  of  sales. — The  cost  of  merchandise  sold  during 
the  period  is  found  by  adding  to  or  subtracting  from  the 
cost  of  manufacturing  (which  inC^ludes  the  cost  of  mate- 
rial, labor,  and  factory  expenses  consumed)  ;  the  decrease 
or  increase  in  the  inventory  of  finished  goods;  the  de- 
crease in  inventory  being  added  to  the  cost,  the  increase 
being  subtracted.  This  method  may  be  made  clearer  by 
the  following  example. 


746  PRINCIPLES  OF  BUSINESS 

Inventory  of  Finished  Goods,  beginning  of  period $100,000 

Cost  of  Manufacturing 350,000 

Total $450,000 

Less  Inventory  of  Finished  Goods  at  the  end  of  period 90,000 

Cost  of  Goods  Sold $360,000 

Or: 

Cost  of  Manufacturing $350,000 

Plus  Decrease  in  Inventory 10,000 

Cost  of  Goods  Sold $360,000 

In  other  words,  we  have  sold  not  only  the  $250,000 
worth  of  goods  manufactured  during  the  year  but,  in 
addition,  $10,000  of  the  goods  remaining  on  hand  at  the 
close  of  the  preceding  year. 

The  cost  of  manufacturing  is  found  by  adding  together 
the  purchases  of  material,  labor  and  factory  expenses  and 
adjusting  them  with  the  increase  or  decrease  in  the  raw 
material  and  work  in  process  inventories — a  decrease  in 
inventory  being  added  to  the  cost  and  an  increase  in 
inventory  subtracted.  The  form  is  sometimes  arranged 
as  follows : 

Inventory — Raw  Alaterials  and  Goods  in  Process  at  the  be- 
ginning of  the  period. 

Purchases^ — Materials    $180,000 

Labor    160,000 

Manufacturing  expense .^ 210,000 

Total $550,000 

Less  Inventory  Raw  Materials  and  Goods  in  Process  at  end 

of   period 200,000 

Cost  of  Manufacturing $350,000 

The  net  result  is  the  same  whichever  arrangement  is 
used,  but  the  layman  may  find  the  adjustment  difficult  to 
understand,  because  of  increase  or  decrease  in  the  inven- 
tory. 

The  valuation  of  inventories  has  been  discussed  in  the 


FINANCIAL   STATEMENTS  747 

early  part  of  this  chapter  and  the  elements  of  factory 
overhead  in  the  chapter  on  cost  accounting.  The  only 
remaining  elem':nts  of  the  cost  of  goods  sold  are  mate- 
rial and  labor. 

To  the  purchases  of  material,  whether  for  cash  or  on 
account,  there  may  be  added  the  cost  of  bringing  the 
material  to  the  factory  or  warehouse,  such  as  freight, 
cartage  and  duty.  Purchases  and  purchase  returns  may 
be  separated,  but  the  reasons  for  their  separation  are  not 
so  important  as  in  the  case  of  sales  and  sales  returns. 

As  to  whether  the  discount  allowed  on  purchase  in- 
voices for  prompt  payment  should  be  deducted  from  the 
amount  of  purchases  or  treated  as  other  income  received, 
authorities  differ.  Those  who  hold  to  the  first  theory 
argue  that  cost  means  net  cost  to  the  purchaser — that 
therefore  the  cost  should  be  the  billed  price  less  the  cash 
discount  received.  The  supporters  of  the  second  method 
base  their  position  on  the  contention  that  the  ability  to 
take  advantage  of  the  discount  is  due  to  the  fact  that  the 
business  has  or  can  command  sufficient  capital  to  enable 
it  to  do  so.  If  the  expense  of  borrowing  capital  is  not 
an  operating  charge,  then  the  benefit  derived  from  suffi- 
cient capital  should  not  be  valued  as  operating  income. 

All  labor  or  services  used  in  the  direct  manufacture  of 
the  product  should  be  included  as  labor,  including  the 
amount  rendered  but  not  paid  for  at  the  date  of  the  ac- 
counting. Labor  or  services  not  directly  connected  with 
the  manufacturing  processes  may  be  shown  as  indirect 
labor  or  may  be  grouped  with  the  general  expenses. 

Percentage  calculations. — The  dift'erence  between  the 
hicome  from  sales  and  the  cost  of  e^oods  sold  is  the  e:ross 


748  PRINCIPLES  OF  BUSINESS 

profit  on  sales.  In  making  comparisons  between  differ- 
ent periods  the  gross  profit  may  be  expressed  as  a  per- 
centage of  gross  profit  either  on  sales  or  on  cost.  Thus 
if  sales  amounting  to  $75,000  cost  $50,000  the  result 
might  be  expressed  as  33  1/3  per  cent  gross  profit  on  sales 
or  50  per  cent  gross  profit  on  cost.  Each  method  has  its 
advantages  and  disadvantages;  the  important  thing  to 
remember  is  that  percentages  calculated  upon  sales  should 
not  be  compared  with  percentages  based  upon  cost. 
Whether  or  not  a  manufacturer  should  base  his  calcula- 
tions upon  sales  depends  upon  the  nature  of  the  business. 
In  some  lines  of  business,  especially  in  popular-priced 
articles,  the  important  problem  is  to  produce  and  sell  the 
goods  at  a  low  enough  price.  The  manufacturer  wants 
to  know  how  much  he  can  allow  for  manufacturing  cost 
on,  let  us  say,  a  $9.00  article.  If  he  is  told  that  his  gross 
profit  on  sales  should  be  33  1/3  per  cent,  he  knows  at  once 
that  his  cost  should  not  exceed  $6.00.  On  the  other 
hand,  if  he  knows  that  'his  cost  is  $6.00  and  desires  to 
know  at  what  price  the  article  should  be  sold,  he  wants  to 
know  what  percentage  he  shoukl  add  to  the  cost  to  in- 
sure himself  a  fair  profit.  Tlie  answer  is,  "You  should 
add  50  per  cent  to  your  cost." 

Turnover. — If  two  concerns  have  the  same  margin  of 
gross  profit  and  one  concern  turns  its  stock  over  twice 
during  the  year  while  the  other  turns  its  stock  over  once, 
it  is  evident  that  the  first  concern  will  make  more  profit 
than  the  second.  One  way  to  calculate  the  rate  of  turn- 
over is  to  divide  the  cost  of  goods  sold  by  the  average 
Inventory  for  the  year.  The  average  inventory  may  be 
found  b)^  taking  the  sum  of  the  inventories  at  the  be- 


FINANCIAL    STATEMENTS  749 

ginning  and  at  the  end  of  the  period,  and  dividing  this 
sum  by  two.  If  stock  records  are  kept,  the  monthly  in- 
ventory should  be  used. 

The  accuracy  of  an  inventory  may  be  checked  by  com- 
paring the  percentage  of  gross  profit  for  the  period  with 
that  of  the  preceding  period  or  periods.  The  percentage 
of  gross  profit  is  also  used  to  estimate  the  inventory  on 
hand  at  a  given  date  in  such  cases  as  when  fire  or  burglary 
losses  are  to  be  estimated. 

Selling  expenses. — All  the  expenses  of  marketing  and 
of  distributing  the  product  should  be  included  under  sell- 
ing expenses.  All  devices  for  securing  trade  are  properly 
chargeable  to  this  group.  Thus  losses  on  old  models 
taken  as  part  of  the  consideration  in  exchange  for  new, 
losses  on  restaurants  in  department  stores,  losses  on  trad- 
ing-stamps, and  similar  expenses  should  be  included  as 
selling  expenses.  The  subtraction  of  the  selling  expenses 
from  the  gross  profit  on  sales  leaves  the  selling  profit. 

General  and  administrative  expenses. — Those  ex- 
penses which  have  to  do  with  the  management  of  the 
enterprise  and  which  cannot  be  apportioned  either  to 
manufacturing  or  selling  activities  ar^  grouped  as  admin- 
istrative expenses.  Included  in  this  group  would  be 
salaries  of  administrative  officers,  depreciation  of  office 
furniture,  cost  of  office  supplies,  stationery,  printing,  tele- 
phone and  telegraph  and  other  miscellaneous  expenses. 
By  deducting  the  general  expenses  wt  arrive  at  the  net 
profit,  as  it  is  sometimes  called,  or  income  from  opera- 
tions. 

The  operating  ratio. — The  cost  of  sales,  selling  ex- 
penses and  administrative  expense  are  often  grouped  to- 


750  PRINCIPLES  OF  BUSINESS 

gether  and  known  as  operating  expenses.  The  percen- 
tage of  operating  expenses  to  gross  income  is  called  the 
operating  ratio.  In  comparing  the  efficiency  of  various 
railroads  and  public  utilities,  a  great  deal  of  importance 
is  attached  to  this  ratio,  a  low  ratio  usually  being  a  sign 
of  efficient  management. 

Other  income. — "Other  Income"  should  include  any 
income  received  other  than  that  from  the  sale  of  the 
product  or  services  of  the  organization.  The  more  com- 
mon items  are :  interest  on  bank  balances  and  on  accounts 
or  notes  receivable,  discount  on  purchases,  rent,  commis- 
sions or  royalties  received,  and  interest  and  dividends  on 
securities  owned. 

Charges  against  income. — All  expenses  incurred  in 
the  procurement  and  protection  of  capital  should  be  in- 
cluded as  charges  against  income.  As  to  certain  items 
there  is  a  dispute  as  to  the  propriety  of  their  inclusion 
under  this  heading.  Taxes  and  rent  on  factory  build- 
ings, some  authorities  argue,  should  be  charged  as  manu- 
facturing expenses.  The  counter  argument  is  that  taxes 
are  sums  paid  for  invested  capital,  and  that  "if  the  con- 
cern did  not  pay  rent  it  would  own  a  factory,  the  carrying 
charges  of  which  would  be  shown  as  charges  against  in- 
come. The  reasons  why  cash  discounts  on  purchases 
should  not  be  deducted  from  the  cost  of  goods  sold  are 
the  very  reasons  why  cash  discounts  on  sales  should  not 
be  deducted  from  sales,  but  included  as  a  charge  against 
income. 

Profit  and  loss  credits  and  charges. — If  we  add  other 
income  and  subtract  the  charges  against  income,  the  re- 
sulting figure  will  be  the  net  income.     This  figure,  how 


FINANCIAL    STATEMENTS  751 

ever,  is  subject  to  still  further  adjustments.  Unusual 
items  of  income,  such  as  profits  from  the  sale  of  assets 
or  recoveries  on  bad  debts,  should  appear  as  profit  and 
loss  credits.  On  the  other  hand  unusual  losses,  such  as 
losses  from  fires,  together  with  provisions  for  contingen- 
cies, and  the  like,  should  be  included  as  profit  and  loss 
charges. 

Distribution  of  net  profits. — After  all  adjustments 
are  made  the  resulting  net  profit  is  available  for  distribu- 
tion. In  the  case  of  sole  proprietors  and  partnerships 
the  net  profits  are  added  to  the  owner's  capital  accounts. 
Any  drawings  during  the  year  and  any  losses  from 
operations  are  charged  to  their  capital  accounts.  In 
the  case  of  a  corporation,  however,  the  net  profits  are 
either  distributed  to  the  stockholders  by  the  directors,  or 
reinvested  in  the  business.  The  directors  of  the  X.Y.Z. 
company,  whose  income  statement  and  balance  sheet  are 
exhibited  in  this  chapter,  declared  a  dividend  of  7  per  cent 
upon  the  preferred  stock  and  one  of  6  per  cent  on  the 
common  stock.  They  also  set  aside  $35,000  as  a  reserve 
for  income  and  excess  profits  taxes.  Federal  income  and 
excess  profits  taxes  are  not  an  expense  of  doing  business, 
nor  are  they  a  capital  charge ;  their  real  nature  is  a  dis- 
tribution of  profits  to  the  silent  partner,  the  Government 
of  the  United  States.  The  balance,  %2y,^2'j,  the  directors 
decide  not  to  distribute,  but  to  keep  in  the  business,  where 
it  becomes  part  of  the  surplus,  and  is  available  for  the 
payment  of  future  dividends. 

Secret  reserves. — Often  the  profits  available  for  divi- 
dends are  greater  than  the  amount  shown  in  the  surplus 
account,  as  a  result  of  the  creation  of  a  secret  reserve.     A 


752  PRINCIPLES  OF  BUSINESS 

secret  reserv^e  is  an  understatement  of  the  surplus,  caused 
by  (i)  providing  unnecessary  reserves  for  depreciation, 
(2)  making  excessive  provision  for  bad  debts,  (3)  charg- 
ing capital  items  to  revenue  accounts,  and  (4)  omitting 
from  the  books  assets  which  are  owned.  Ordinarily, 
secret  reserves  are  a  source  of  strength  in  that  they  pre- 
vent the  distribution  of  the  entire  surplus,  and  in  that 
they  may  be  drawn  upon  to  equalize  dividends  in  lean 
years.  The  principal  objections  to  a  secret  reserve  are 
that  it  is  misleading  and  often  works  an  injustice  to 
stockholders  who  may  dispose  of  their  stock  upon  the 
basis  of  the  apparent  condition  of  the  business,  and  that 
it  opens  the  way  for  manipulation  of  the  accounts  by  the 
directors  to  conceal  losses  due  to  mismanagement. 

Consolidated  statements. — Modern  developments  in 
business  have  resulted  in  a  form  of  organization  known 
as  the  holding  company.  A  holding  company  is  one 
which,  by  ownership  of  the  stock  of  other  companies, 
controls  their  operations.  Such  controlled  companies  are 
known  as  "subsidiaries."  Although  the  holding  com- 
pany may  own  all  the  stock  of  a  subsidiary  it  does  not 
own  the  assets  of  the  company.  The  balance  sheet  of 
the  holding  company  would  show — as  assets — stocks  and 
bonds  owned,  while  its  liabilities  usually  would  consist 
of  collateral  trust  bonds  and  short-term  notes.  Its  in- 
come statement  would  show  dividends  and  interest  re- 
ceived less  general  expenses  and  interest  paid.  Such 
statements,  however,  do  not  furnish  the  information 
which  the  stockholders  and  creditors  of  the  holding  com- 
pany desire.  They  wish  to  know  the  condition  of  the 
subsidiaries    as    well.      The    accountant,    realizing    that 


FINANCIAL    STATEMENTS  753 

the  function  of  financial  statements  is  to  furnish  informa- 
tion, takes  it  upon  himself  to  prepare  a  consolidated  bal- 
ance sheet  and  a  consolidated  income  statement.  These 
statements  have  no  foundation  in  law,  but  custom  has 
forced  holding  companies  to  furnish  such  statements.  The 
consolidated  statements  set  forth  the  financial  condition 
and  operations  of  the  group  of  affiliated  corporations  as 
one  enterprise;  all  intercompany  transactions  and  obliga- 
tions are  eliminated,  and  only  the  purchases  and  sales 
made  by  the  group  to  outsiders  are  included — while  the 
balance  sheet  shows  only  the  liabilities  due  to  outsiders 
and  the  capital  stock  held  by  outsiders. 

Many  difficulties  arise  in  the  preparation  of  these  state- 
ments, such  as  that  of  the  elimination  of  intercompany 
profits  included  in  inventories,  and  the  difficulty  of  show- 
ing the  minority  stockholders'  interest  in  the  surplus  of 
subsidiary  companies.  These  problems,  important  as 
they  are,  do  not  come  within  the  limited  scope  of  this 
volume. 

BIBLIOGRAPHY 

Stockwell,  H.  G.,  Nei  Worth  and  the  Balance  Sheet. 

Kniffen,  W.  H.,  Commercial  Paper  and  the  Analysis  of  Credit 
Statements,  Part  II. 

Montgomery,  R.  H.,  Auditing  Theory  and  Practice. 

Cole,  William  M.,  Accounts,  Their  Construction  and  Interpreta- 
tion. 

Bennett,  R.,  Corporation  Accounting,  Part  V. 

Babson  and  May's,  Commercial  Paper. 

Greene,  Thomas  L.,  Corporation  Finance,  ch.  V. 

Saliers,  Earl  A.,  Financial  Statements  Made  Plain. 


CHAPTER   XXXI 

COST  ACCOUNTING 

What  cost  accounting  is. — Cost  accounting,  a  branch 
of  general  accounting,  has  for  its  purpose  the  providing 
of  detailed  information  as  to  the  separate  elements  of 
cost  which  have  entered  into  an  article  or  product.  Gen- 
eral accounting  shows  merely  the  total  profit  or  loss  re- 
sulting from  the  operations  of  the  business;  cost  account- 
ing shows  the  profit  or  loss  on  each  unit,  whether  the  unit 
be  a  department,  a  process,  or  a  single  job. 

Theoretically,  any  type  of  accounting  which  reveals 
the  result  of  the  operations  of  the  various  parts  of  a  busi- 
ness, such  as  the  system  used  in  department  stores,  might 
be  called  cost  accounting;  in  common  usage,  however, 
the  term  "cost  accounting"  is  applied  only  to  that  type 
of  accounting  which  deals  w'ith  the  costs  of  manufactur- 
ing, mining  and  other  businesses,  where  material  and 
labor  enter  directly,  so  to  speak,  inio  the  finished  product. 
The  principles  of  cost  accounting  developed  in  this  chap- 
ter, therefore,  while  applicable  to  any  type  of  business, 
are  explained  and  illustrated  in  their  application  espe- 
cially to  manufacturing  rather  than  to  merchandising 
businesses. 

Insufficiency  of  general  accounting. — With  a  good 
system  of  general  accounting,  the  business  man  can  ascer- 
tain at  the  close  of  each  fiscal  period  the  amount  of  the 
profit  or  loss  which  has  resulted  from  the  operation  of 
his  business.     The  fiscal  period  may  be  as  long  or  as 

754 


COST  ACCOUNTING  755 

short  a  period  as  he  desires,  depending  entirely  upon  how 
often  he  is  wilHng  to  go  to  the  trouble  of  taking  an  in- 
ventory. The  information  he  gets  by  means  of  general 
accounting,  however,  is  merely  the  total  amount  of  his 
profit  or  loss  for  the  period.  If  a  profit  has  resulted,  he 
may  be  satisfied ;  if  a  loss  is  indicated,  he  may  have  no 
means  of  ascertaining  the  cause,  or  of  determining  how 
to  prevent  future  losses.  The  days  when  he  could  offset 
the  loss  by  raising  his  prices  are  past.  He  must  meet  the 
competition  of  other  business  men,  and  his  prices  can- 
not be  raised  arbitrarily  simply  because  his  business  may 
have  showed  a  loss  for  the  past  period.  He  must  know 
which  lines  of  his  business  are  operating  at  a  loss,  and 
which  are  showing  a  profit.  If  he  has  this  information 
he  can  direct  his  efforts  toward  manufacturing  or  selling 
the  more  profitable  lines. 

General  figures  are  often  misleading.  A  business  as  a 
whole  may  show  satisfactory  results,  yet  one  department 
may  be  carrying  the  losses  of  the  other  departments.  The 
insufiicienc}^  of  general  figures  is  well  illustrated  by  the 
following  incident :  A  manufacturer  had  for  a  number 
of  years  conducted  a  profitable  business,  making  a  grade 
of  hats  to  sell  at  $3.  In  the  year  19 16,  he  brought  out  a 
new  style  which  proved  so  popular  that  the  manufacturer 
practically  discontinued  his  other  lines  and  devoted  all 
his  facilities  to  manufacturing  the  ''leader,"  which  also 
was  priced  at  $3.  At  the  end  of  the  year,  after  almost 
doubling  his  gross  sales,  he  was  greatly  surprised  to  find 
that  he  had  actually  lost  $10,000.  After  a  careful  in- 
vestigation, he  discovered  that  each  hat  he  had  sold  had 
cost  him  $3.25.     It   is  not   surprising  that   one  of  his 


756  PRINCIPLES  OF  BUSINESS 

competitors  had  found  it  cheaper  to  buy  from  him  than 
to  manufacture  hats  himself. 

Functions  and  uses  of  cost  systems.— -The  first  func- 
tion of  a  system  of  cost  accounting  is  the  calculation  of 
the  cost  of  each  unit  of  production.  The  information  so 
obtained  may  be  used  in  the  intelligent  adjustment  of  sell- 
ing prices ;  or  if  those  prices  are  fixed  by  trade  customs, 
in  directing  selling  efforts  into  the  more  profitable  lines. 
Not  only  the  individual  manufacturer,  but  also  the  whole 
industry  is  benefited  by  the  installation  of  cost  accounting 
systems,  since  the  manufacturer  who  does  not  have  a 
cost  system,  but  who  fixed  his  prices  by  "guess-work," 
may  drag  others  to  ruin  with  him.  The  manufacturer 
who  knows  what  his  products  cost  him  must  nevertheless 
meet  the  competition  fixed  by  the  one  who  does  not  know. 
As  a  result  of  the  efforts  of  the  Federal  Trade  Commis- 
sion and  of  the  various  Manufacturers'  Associations,  uni- 
form cost  systems  have  been  adopted  in  a  number  of  in- 
dustries. 

The  second  function  of  cost  accounting  is  to  furnish  a 
basis  for  comparisons — to  present  the  cost  of  each  unit  in 
such  detail  that  the  total  cost  and  the  various  elements  of 
the  cost  may  be  compared  with  past  costs  of  similar  units, 
with  the  estimated  cost  of  the  same  unit,  and  subsequently 
with  the  cost  of  similar  units.  In  order  to  make  cost 
records  valualjlc  for  comparisons  as  between  different 
periods,  it  is  often  necessary  to  keep  the  details  in  terms 
of  units  of  material  and  labor^  as  well  as  in  terms  of  dol- 
lars and  cents. 

A  third  function  of  a  cost  system  is  to  furnish  the  fac- 
tory manager  with  detailed  information  as  to  the  opera- 


COST  ACCOUNTING  757 

tion  of  the  factory.  This  information  is  a  sort  of  by- 
product of  the  cost  accounting  system,  but  the  use  the  fac- 
tory executive  can  make  of  it  is  almost  unhmited.  Some 
of  the  data  here  referred  to  include :  idle  time,  by  depart- 
ments, machines,  or  operations ;  production,  by  machines, 
departments,  or  operators.  The  executive  may  utilize 
this  information,  for  example,  in  making  comparisons  of 
the  services  or  output  of  the  various  superintendents, 
foremen,  employees,  and  production  centers.  He  may 
use  it  to  prevent  "leakage"  of  material  and  labor,  or  in 
ascertaining  the  relative  advantages  of  machinery  as  com- 
pared with  hand-work  in  any  operation. 

So  much  has  been  written  and  said  about  cost  account- 
ing that  manufacturers  have  expected  a  cost  system  to  be 
a  panacea  for  all  their  business  ills.  ,A  cost  system  in 
itself,  however,  cannot  save  a  business  a  single  cent ;  all 
it  can  do  is  to  furnish  information  leading  to  better  man- 
agement. The  use  that  is  made  of  the  information  deter- 
mines the  value  of  the  cost  system.  A  cost  system  is  a 
diagnosis — not  a  cure. 

The  elements  of  cost. — Before  considering  the  prin- 
ciples or  methods  of  cost  accounting,  we  must  decide  just 
what  we  mean  by  *'cost."  "Cost"  is  defined  by  the 
Federal  Trade  Commission  as  "the  amount  or  equivalent 
paid  for  anything."  Since  the  manufacturer  does  not 
make  any  profit  until  his  product  is  sold,  the  cost  he  de- 
sires to  ascertain  is  that  of  making  and  sclliiuj  his  prod- 
uct. The  difference  l')et\veen  that  figure  and  his  selling 
price  is  his  profit.  The  elements  that  make  up  the  cost 
of  manufacturing  and  selling  are  shown  in  the  following 
diag^ram : 


758  PRINCIPLES  OF  BUSINESS 


Direct  Material 

Direct  Labor 

Mfg.  Overhead 

PRIME  COST 

Selling  and 

Administrative 

Expense 

MANUFACTURING  COST 

PROFIT 

COST  TO  MAKE  AND  SELL 

SELLING  PRICE 

The  terms  employed  in  designating  the  various  ele- 
ments of  cost  are  not  always  those  which  are  used  in  this 
chart.  Thus,  "direct  labor"  is  frequently  called  "produc- 
tive labor;"  "manufacturing  overhead"  is  known  as  "fac- 
tory overhead,"  "on-cost"  or  "burden;"  while  "selling 
and  administrative  expense"  is  often  designated  as  "gen- 
eral overhead."  Nor  is  there  any  general  agreement  as 
to  the  separate  items  which  are  to  be  included  under  these 
headings. 

Direct  Materials. — Direct  materials  are  those  mate- 
rials which  form  a  part  of  or  which  are  applied  directly 
to  the  product  and  which  it  is  practicable  to  charge 
directly  to  the  product.  In  shoe  manufacturing,  for 
example,  both  the  oil  used  in  the  heeling  machine  and 
the  leather  used  in  the  heel  are  materials ;  the  latter,  how- 
ever, goes  directly  into  the  shoe,  and  is  classed  as  direct 
material,  while  the  former  does  not  form  part  of  the  prod- 
uct, although  it  is  necessary  in  the  process  of  manufacture. 
The  oil,  therefore,  is  classed  as  "indirect  material."  In- 
direct materials  may,  accordingly,  be  considered  a  part  of 
the  manufacturing  overhead  which  is  prorated  over  the 
product  (as  will  be  explained  later)  by  any  one  of  a 
number  of  different  methods. 


COST   ACCOUNTING  759 

Direct  materials  often  treated  as  indirect  materials. 

— The  amount  of  some  particular  kind  of  material  used 
in  each  unit  of  the  product  may  be  so  small,  or  the  diffi- 
culty of  measuring  the  quantity  used  in  each  unit  may  be 
so  great,  that  it  may  be  impracticable  to  charge  the  mate- 
rial direct  to  the  product.  The  trouble  and  expense  of 
making  a  separate  entry  for  the  small  quantity  of  glue 
used  in  making  a  desk,  for  example,  would  outweigh  the 
advantages  of  exactness  in  the  calculation  of  the  separate 
units  of  cost.  Hence,  some  materials  which  really  are 
direct  materials  are  for  convenience  included  in  the  manu- 
facturing overhead.  In  some  industries,  the  amount  of 
such  semi-direct  material  is  so  large  that  to  "throw"  it 
into  overhead  is  not  a  satisfactory  solution  of  the  prob- 
lem. The  method  used  is  to  charge  such  materials  to  a 
separate  account,  such  as  "findings,"  and  to  charge  each 
unit  with  the  estimated  amount  of  findings  used.  The 
accuracy  of  the  estimate  is  checked  up  at  the  end  of  the 
fiscal  period  by  comparing  the  actual  amount  of  findings 
on  hand  with  the  amount  shown  to  be  on  hand  by  the 
findings  account.  If  the  actual  inventory  is  less  than  the 
estimated,  it  is  proof  that  the  estimate  has  been  too  low. 

It  is  evident  that  the  greater  the  percentage  of  material 
charged  directly  to  the  product,  the  more  accurate  is  the 
cost  information  obtained.  The  cost  accountant,  there- 
fore, is  often  called  upon  to  devise  methods  of  measur- 
ing materials  in  order  to  permit  of  their  being  charged 
directly  to  the  product. 

Cost  of  materials. — Materials  should  be  entered  upon 
the  books  and  charged  to  the  product  at  cost.  But  what 
should  we  consider  as  being  the  cost  of  "materials  pur- 


76o  PRINCIPLES  OF  BUSINESS 

chased"?  Theoretically,  every  one  will  agree  that  the 
cost  of  merchandise  is  the  cost  of  getting  it  to  the  place 
where  it  is  to  be  used,  that  is,  the  billed  price,  plus  duty, 
freight,  cartage,  insurance,  and  the  like.  When  we  stop 
to  consider  that  all  these  additional  charges  will  have  to 
be  expressed  in  terms  of  cost  per  unit,  we  must  again 
come  to  the  conclusion  that  absolute  accuracy  must  be 
sacrificed  to  practicability,  and  that  charges  for  freight, 
cartage,  and  other  like  items  should  be  included  in  manu- 
facturing overhead.  However,  these  "inward"'  charges 
are  often  prorated  over  the  different  materials  purchased, 
as  a  percentage  of  their  respective  values. 

The  question  of  cash  discounts  must  also  be  considereci. 
Those  who  claim  that  cash  discounts  decrease  the  cost 
of  merchandise  will  of  course  enter  materials  at  the  billed 
price  less  discount,  while  those  who  believe  that  discounts 
deducted  on  purchases  are  income  arising  from  the  use 
of  capital  will  enter  invoices  at  the  billed  price.  Per- 
haps the  best  suggestion  on  this  point  is  that  made  by 
Professor  Cole^ — that  invoices  should  be  entered  "net'' 
— that  is,  less  all  possible  discounts,  the  difference  be- 
tween the  face  and  net  amounts  of  the  bill  being  charged 
to  an  account  called  "neglected  discounts."  The  amounts 
of  discount  actually  deducted  at  the  time  of  payment  are 
credited  to  Neglected  Discounts.  The  debit  balance  of 
this  account  will  show,  as  its  title  indicates,  the  amount 
of  discount  of  which  advantage  is  not  taken.  The  basis 
of  this  argument  is  that  the  true  cost  of  merchandise  is 
the  lowest  price  at  which  the  seller  is  willing  to  dispose  of 
it,  and  that  by  not  taking  advantage  of  discounts  offeied. 

^  William  Alorse  Cole,  Accounts,  Their  Construction  and  Intcrf,ye- 
tation. 


COST  ACCOUNTING  761 

we  are  not  increasing  the  cost  of  the  goods,  but  incurring 
an  expense  due  to  lack  of  capital. 

Direct  labor. — Direct  labor  includes  the  wages  of  all 
employees  working  directly  upon  the  product.  Indirect 
or  non-productive  labor  is  that  which  cannot  economically 
be  charged  directly  to  the  product,  but  which  is  "lumped" 
with  the  manufacturing  overhead,  and  distributed  over 
the  output — for  example,  the  wages  of  foremen,  inspec- 
tors, sweepers  and  watchmen.  Wherever  possible,  labor 
should  be  classed  as  direct  rather  than  indirect.  The 
wages  of  machinists'  helpers  ma}^  be  treated  as  direct 
labor  and  charged  to  the  various  units  on  the  same  basis 
as  that  of  the  machinists  whom  they  help. 

Manufacturing  overhead. — All  items  of  cost  other 
than  those  included  in  direct  material  and  direct  labor 
constitute  the  "overhead."'  For  cost  accounting  purposes 
overhead  is  divided  into  "manufacturing  overhead''  and 
"general  overhead."  By  adding  the  manufacturing  over- 
head to  the  prime  cost,  we  obtain  the  "factory  cost"  or 
"cost  of  manufacturing."  All  the  elements  comprising 
factory  cost  are  within  the  control  of  the  factory  man- 
ager and  it  is  customary  to  hold  him  responsible  for  them. 
On  the  other  hand,  the  selling  and  administrative  ex- 
penses, or  the  general  overhead,  are  not  within  his  con- 
trol. It  is  therefore  important  to  distinguish  between 
manufacturing  overhead  and  general  overhead. 

Allocation  of  certain  expenses. — ^Unfortunately,  ac- 
countants do  not  agree  as  to  the  allocation  of  certain 
items  of  expense.  The  chief  dispute  centers  about  those 
items  which  are  classed  in  the  "Statement  of  Income, 
Profit  and  Loss"   (see  the  chapter  on  "Financial  State- 


762  PRINCIPLES  OF  BUSINESS 

ments"),  as  charges  against  income — namely,  the  items 
of  rent,  interest,  depreciation  of  buildings,  taxes  and  in- 
surance. 

Our  argument  for  placing  interest,  depreciation  of 
buildings,  taxes,  and  insurance  on  buildings  in  the  section 
headed  "charges  against  income"  ^  is  that  these  items  are 
charges  for  the  use  or  protection  of  capital  and  that  they 
should  be  offset  against  the  income  resulting  from  the  use 
of  the  capital — that  if  we  actually  owned  our  capital 
assets,  we  should  have  no  interest  to  pay.  Rent  is  in- 
cluded, since  it  is  considered  that  rent  is  a  substitute  for 
the  payment  of  interest  and  taxes.  The  layman  and  a 
great  number  of  accountants  also  feel  that  rent  is  a  cost 
as  much  as  is  the  payment  of  w'ages.  If  the  concern 
which  pays  rent  includes  the  amount  paid  as  a  cost — 
then,  to  be  consistent,  the  concern  which  owns  the  land 
and  buildings  should  also  make  a  charge  for  rent.  It  is 
not  sufficient  that  the  expenses  of  owning  the  building 
(i.e.  taxes,  depreciation,  and  interest)  be  charged  as 
manufacturing  expenses.  The  business  has  money  in- 
vested in  the  property,  on  which  it  is  entitled  to  a  fair 
return.  This  property  is  at  the  disposal  of  the  manu- 
facturing department,  and  should  be  paid  for.  The  solu- 
tion of  the  problem  is  to  make  a  charge  for  the  reasonable 
rental  value  of  the  property  to  the  manufacturing  depart- 
ment. The  accounts  would  then  show  the  true  cost  of 
manufacturing  and  would  show  also  the  income  received 
by  the  business  as  owner  of  the  land.  As  a  device  for 
distinguishing  clearly  between  profits  arising  from  manu- 
facturing, and  those  arising  from  the  ownership  of  real 

^See  the  chapter  on  "Financial  Statements." 


COST   ACCOUNTING  7^3 

estate,  the  practice  of  organizing  a  separate  corporation 
to  hold  the  title  to  real  estate  has  its  advantages. 

If  we  are  to  make  a  charge  for  rent — which  charge 
includes  interest  on  the  capital  invested — why  should  we 
not  make  a  charge  for  all  capital  invested?  The  basic 
question  is,  whether  or  not  any  additional  accuracy  in 
cost  records  can  be  obtained  by  including  a  charge  for  in- 
terest among  the  manufacturing  expenses.  Of  course, 
such  an  entry  cannot  affect  the  net  profit  or  loss  of  the 
business  as  a  whole,  because  the  business  neither  receives 
nor  pays  out  anything  of  value.  In  general,  it  is  desir- 
able to  include  interest  in  cost :  ( i )  where  materials  must 
be  stored  for  long  periods  while  a  seasoning  process 
is  being  completed;  (2)  where  it  is  desired  to  show  the 
effects  of  variations  in  the  amount  of  capital  employed 
and  in  the  lengths  of  the  periods  during  which  the  capital 
is  employed. 

In  the  first  case,  we  can  readily  see  that  if  the  mer- 
chandise were  purchased  in  a  seasoned  state,  a  higher 
price  would  have  to  be  paid,  which  price  would  neces- 
sarily include  interest  and  other  carrying  charges.  The 
interest  on  the  capital  tied  up  during  the  seasoning  period 
is  clearly  a  direct  part  of  the  cost. 

To  illustrate  the  second  case,  we  may  take  that  of  a 
shoe  factory  making  two  classes  of  shoes — one  bench- 
made,  the  other  machine-made.  In  the  making  of  the 
latter  class,  thousands  of  dollars  worth  of  machinery  must 
be  emplo3ed,  while  in  turning  out  the  hand-made  shoes 
only  a  bench  and  a  few  simple  tools  are  required.  The 
difference  between  the  cost  and  the  selling  price  of  the 
hand-made  shoes  is  almost  entirely  profit,  while  the  mar- 


764  PRINCIPLES  OF  BUSINESS 

gin  on  the  machine-made  line  must  include  a  return  for 
the  use  of  capital.  In  order  that  the  difference  between 
the  cost  and  selling  price  of  any  unit  may  represent  the 
actual  profit,  there  must  be  added  to  the  cost  of  the 
product  a  charge  for  the  interest  on  the  capital  employed 
in  its  manufacture. 

Arguments  against  the  inclusion  of  interest  in  cost. 
— There  are  certain  practical  objections,  however,  to 
including  interest  as  an  element  of  cost : 

1.  Inventories  become  inflated.  Goods  in  process  and 
finished  goods,  being  inventoried  at  cost,  will  include  in- 
terest. 

2.  The  interest  charge  must  be  made  at  an  arbitrary 
rate.  Three  possible  rates  may  be  used;  (a)  the  pure 
interest  rate,  which  is  the  charge  for  the  use  of  money 
where  the  risk  is  zero  ;^  (b)  the  rate  at  which  money  could 
be  borrowed,  which  in  turn  depends  upon  the  security 
offered,  or  (c)  the  rate  which  the  given  business  might 
be  expected  to  earn  as  a  reasonable  rate. 

3.  The  interest  charge  is  difficult  to  compute,  since 
the  charge  for  the  use  of  the  capital  must  be  made  on  the 
double  basis  of  value  and  time.  The  determination  of  the 
interest  charges  on  current  assets,  which  assets  are  never 
constant,  is  almost  impossible. 

4.  The  problem  of  the  distribution  of  overhead  charges 
is  made  more  complex.  All  methods  of  distributing 
overhead  are  more  or  less  arbitrary  and  it  is  desirable, 
therefore,  to  reduce  the  distributable  overhead  to  a  mini- 
mum.    If  we  consider  the  contributors  of  money  to  the 

^  The  element  of  risk  is  never  altogether  absent;  the  pure  inter- 
est rate,  therefore,  is  always  merely  a  theoretical  rate. 


COST  ACCOUNTING  765 

business  as  partners  whose  returns  must  be  secured  out 
of  the  margin  between  sales  price  and  cost  price,  we  can 
adjust  all  differences  in  length  of  processes  and  capital 
required  by  raising  or  lowering  this  margin.  The  mar- 
gin of  profit  should  vary  inversely  as  the  ratio  of  sales 
to  capital — that  is,  the  margin  of  profit  in  an  industry  in 
which  the  amount  of  the  annual  sales  equals  that  of  the 
capital  employed  should,  the  risk  being  equal,  be  four 
times  as  great  as  that  in  an  industry  where  the  amount 
of  the  annual  sales  is  four  times  the  amount  of  the 
capital  employed. 

Cost  records. — The  primary  function  of  cost  account- 
ing, as  we  have  noted  above,  is  the  calculation  of  the 
cost  of  each  unit  produced.  By  "each  unit"  we  do  not 
mean  that  in  a  shoe  factory,  for  example,  we  should  de- 
termine separately  the  exact  cost  of  each  pair  of  shoes. 
The  unit  is  the  division  of  the  total  production  to  which 
the  costs  are  applied ;  it  may  be  a  single  pair  of  shoes,  a 
lot  of  shoes  made  at  one  time,  or  the  entire  year's  pro- 
duction of  a  single  style.  Some  of  the  factors  which 
should  influence  the  selection  of  the  accounting  unit  are 
discussed  later  in  this  chapter.  Cost  records  should 
therefore  contain  the  information  as  to  the  amount  of 
materials,  labor  and  overhead  applicable  to  each  unit. 

Material  records. — The  cost  for  material  allocated  to 
each  unit  is  dependent  upon  the  quantity  and  the  price 
per  unit  of  the  material  used.  Obviously,  an  accurate 
record  of  the  quantity  of  material  used  for  each  unit  can 
be  kept  most  easily  if  one  person  is  made  responsible  for 
the  care  and  issuance  of  all  the  material.  This  person  is 
usually  given  the  title  of  "stores  clerk.''     Materials  are 


766  PRINCIPLES  OF  BUSINESS 

issued  by  the  stores  clerk  only  upon  an  order  known  as 
a  "material  requisition,"  or  "bill  of  material,"  which  may 
be  made  out  by  the  foreman,  superintendent  or  an  official 
of  the  planning  department.  Each  requisition,  besides 
containing  a  list  of  the  materials  required,  should  bear  a 
serial  number,  and  also  the  number  of  the  unit  on  which 
the  material  is  to  be  used.  The  requisition  may  bear  the 
same  number  as  that  of  the  production  order — an  order 
authorizing  the  manufacture  of  a  unit  of  the  product,  and 
bearing  a  number  by  which  the  job  is  identified  through- 
out the  manufacturing  process.  In  some  of  the  manufac- 
turing processes,  such  as  assembling,  it  is  possible  to  enter 
on  the  requisition,  in  advance,  the  exact  amount  of  mate- 
rial to  be  used.  In  such  cases  the  stores  clerk  issues  the 
material  called  for  by  the  requisition,  prices  the  mate- 
rials,^ enters  on  his  stock-records  the  amount  of  materials 
issued,  and  then  turns  the  requisition  over  to  the  "cost 
clerk."  If  the  amount  of  material  required  is  not  pre- 
cisely determined,  the  amount  issued  will  usually  be  in 
excess  of  the  requirements,  unused  material  being  re- 
turned. This  situation  may  be  met  by  putting  through 
the  requisition  for  the  total  amount  issued  and  then  mak- 
ing out  a  credit  memorandum  or  "stores-returned  slip" 
for  the  amount  returned.  A  somewhat  simpler  method 
is  to  hold  up  the  requisition  until  the  actual  amount  used 
is  determined,  a  memorandum  serving  to  record  the 
amount  of  materials  originally  issued. 

Pricing  of  material  requisitions. — The  materials 
should  be  charged  to  the  work  in  process  at  cost.  Where 
the  same  material  has  Ijeen  purchased  at  different  prices, 

1  In  cases  where  secrecy  is  required,  the  pricing  is  done  by  the 
cost  clerk. 


COST  ACCOUNTING  767 

there  is  a  difference  of  opinion  as  to  the  price  which 
should  be  used.  The  most  equitable  method  would  seem 
to  be  to  "charge  out"  the  material  in  the  order  received — 
that  is,  if  material  has  been  purchased  in  three  succeed- 
ing lots  at  $.50,  $.60  and  $.70  p^r  pound,  respectively,  all 
the  material  purchased  at  $.50  should  be  charged  out 
before  any  at  $.60  is  used.  The  store  room  should  be 
so  arranged  as  to  permit  the  physical  material  to  be  dis- 
posed of  in  the  same  order.  Another  method  is  to  aver- 
age the  price  and  charge  out  all  units  at  the  same  price. 
This  means  that  the  average  price  must  be  recalculated 
each  time  new  material  is  purchased.  A  third  method 
is  to  use  the  latest  price  at  all  times.  The  effect  of  this 
method  is  to  inflate  the  cost  of  production  in  times  of 
rising  prices,  and  to  undercharge  the  work  in  process 
when  prices  are  dropping.  The  last  two  methods  have 
the  additional  disadvantage  of  carrying  the  inventory  at 
prices  which  do  not  represent  the  cost  of  the  material  on 
hand. 

The  problem  of  by-products. — One  of  the  most  in- 
teresting problems  of  cost  accounting  is  that  of  by-prod- 
ucts. Where  one  product  is  produced  as  an  indirect 
result  of  the  manufacture  of  the  main  product  what 
should  be  considered  the  cost  of  the  by-product  ?  To 
illustrate:  to  make  a  pair  of  "ladies'  buck  shoes"  takes 
five  feet  of  "buck"  at  $.80  a  foot.  The  small  pieces  left 
over  are  used  to  make  children's  shoes.  What  is  the 
material  cost  of  a  pair  of  "ladies'  "shoes?  Should  we 
say  $4.00,  on  the  ground  that  we  used  up  the  five  feet 
of  leather,  and  that  anything  obtained  from  the  small 
pieces  is  "found  money;"  or  should  we  say  that  it  is  lesg 


;68  PRINCIPLES  OF  BUSINESS 

than  $4.00;  that  the  leather  in  the  children's  shoes  did 
cost  something?  If  the  latter,  what  figure  should  we 
use?  There  are  two  figures  which  can  be  used — (i)  the 
cost  of  similar  small  pieces  of  leather  if  purchased  in  the 
open  market;  or  (2)  the  price  which  could  be  realized  if 
the  pieces  were  disposed  of.  Either  figure 'would  be 
acceptable,  as  there  is  v.ery  little  to  choose  between  them. 

Related  to  the  problem  of  by-products  is  that  of  scrap. 
Ordinarily,  the  amount  recovered  by  the  sale  of  cuttings, 
clippings,  sawdust,  and  the  like,  does  not  enter  into  cost 
calculations.  But  the  scrap  of  today  is  the  source  of  the 
by-product  of  tomorrow.  Where  the  value  of  the  scrap 
is  considerable,  it  is  advisable  to  credit  the  cost  of  pro- 
duction and  charge  a  ''scrap  account''  with  the  amount  of 
scrap  on  each  unit. 

Perpetual  inventories. — If  the  stores  clerk  is  to  be 
made  responsible  for  the  recording  of  the  materials  issued, 
he  must  be  responsible  also  for  the  materials  on  hand.  It 
is  evident  that  if  we  charge  him  with  all  he  receives  and 
credit  him  with  all  he  issues,  the  balance  will  be  the 
amount  he  should  have  on  hand.  If  the  amount  actually 
on  hand,  as  shown  by  a  physical  inventory,  agrees  with 
this  balance,  it  is  proof  that  his  work  has  been  properly 
performed.  The  amount  which  should  be  on  hand  is 
found  by  a  comparison  of  the  amount  purchased  with 
the  total  of  the  requisitions  issued.  Records  are  kept, 
of  course,  of  each  separate  class  of  material.  Each  stock 
sheet  should  be  provided  with  spaces  entering  ( i )  the 
number  of  units  received ;  the  cost  per  unit ;  and  the 
amount;  and  (2)  the  numljcr  of  units  issued;  the  cost  per 
unit;  and  the  amount — the  sheet  or  card  being  headed 


COST   ACCOUNTING  769 

with  the  name  of  the  item,  or  its  number  or  mnemonic 
symbol.  Additional  information  may  be  recorded  on  the 
sheets,  such  as :  quantity  ordered,  quantity  applied  on 
orders,  balance  available,  minimum  and  maximum  quan- 
tities, and  so  on.  A  typical  stock  sheet  is  illustrated  on 
the  following  page. 

The  total  amounts  entered  on  the  stock  cards  as  re- 
ceived must  be  charged  in  total  to  the  Materials  Account 
in  the  general  ledger.  The  charge  to  the  Materials  Account 
is  usually  made  from  the  purchase  journal  or  voucher 
register.  Various  devices  are  used  to  insure  that  all 
merchandise  has  been  received  and  properly  entered  on 
the  stock  record. 

The  requisitions,  as  previously  explained,  are  priced 
and  extended.^  From  the  requisitions,  postings  of  the 
amounts  of  material  issued  are  made  to  the  stock  sheets. 
The  total  of  all  requisitions  is  posted  periodically — daily, 
weekly,  or  monthly — to  the  credit  side  of  the  Materials 
Account  in  the  general  ledger.  The  balances  of  the 
stock  sheets,  in  dollars  and  cents,  are  listed  monthly,  and 
should  always  agree  in  total  with  the  balance  of  the  Mate- 
rials Account.  Comparison  of  the  stock  sheets  with  the 
actual  stock  need  not  be  deferred  until  the  close  of  the 
fiscal  period;  inventories  of  different  classes  of  goods 
can  be  taken  at  different  times.  This,  of  course,  does 
away  with  the  troublesome  and  expensive  annual  inven- 
tory, which  often  means  the  closing  down  of  the  factory 
for  several  days. 

Discrepancies  between  the  stock  record  and  the  physical 
inventory  may  be  due  to  loss  in  weight,  carelessness  in 

^The  detailed  prices  of  the  materials  are  shown  and  the  total 
amount  of  the  requisition. 


770 


PRINCIPLES  OF  BUSINESS 


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COST  ACCOUNTING  771 

issuance,  or  theft.  When  such  discrepancies  are  noted, 
the  stock  record  should  be  adjusted  to  agree  with  the 
actual  stock. 

Labor  records. — The  chief  purpose  in  the  recording  of 
labor  costs  is  to  ascertain  the  cost  of  the  labor  applicable 
to  each  unit.  Where  the  laborers  are  paid  by  piece-work, 
little  difficulty  is  experienced  in  obtaining  the  necessary 
information.  Care  must  be  taken,  of  course,  to  enter 
correctly  the  production  numbers  of  the  units  produced. 
To  this  end,  a  coupon  for  each  piece-work  operation  is 
usually  attached  to  the  production  order.  This  coupon 
contains  the  production-order  number,  the  number  of 
units  in  the  order,  and  the  rate  per  unit  to  be  paid  for 
the  operation.^  The  coupon  is  detached  by  the  worker 
and,  after  being  "O  K"d"^by  the  foreman,  it  is  turned  in 
to  the  payroll  department.  Of  course  this  means  that  the 
distribution  of  the  labor  charges  to  the  production  units 
is  delayed  until  after  the  worker  has  been  paid. 

Where  the  worker  is  paid  by  the  day  or  b}'  the  week, 
it  is  necessary  to  record  the  time  spent  by  each  worker 
on  each  unit.  The  total  time  for  which  the  worker  is 
paid  must  be  accounted  for  and  distributed  to  the  various 
units.  If  this  is  not  done,  the  total  amount  charged  to 
work  in  process  (which  is  the  total  of  the  direct-labor 
payroll)  will  not  agree  with  the  total  amounts  charged 

1  In  some  industries,  where  the  piece-rates  are  complicated,  it 
has  been  found  that  the  clerks  preparing  the  coupons  make  erro.s 
in  the  rates,  which  when  in  favor  of  the  employee  are  seldom  or 
never  reported  to  the  office  when  the  coupons  are  checked  up ;  any 
time  for  which  the  employee  is  paid  and  which  is  not  accounted 
for  by  a  job  ticket  should  be  charged  to  "lost  time."  Loss  may 
be  due  to  lateness  in  starting  work  in  the  morning  and  at  noon, 
delays  between  jobs  or  payment  for  holidays.  "Lost  time"  by  this 
method  stands  out  as  a  separate  factor  of  cost  and  may  therefore 
be  controlled. 


772  PRINCIPLES  OF  BUSINESS 

to  the  various  cost  units.  The  use  of  time  clocks  or 
stamps  for  recording  starting  and  finishing  time  in  each 
"job"  is  perhaps  the  most  accurate  method  of  obtaining 
the  necessary  information.  The  payroll  should  prefer- 
ably be  made  up  from  a  time  record  kept  independently 
of  the  job  record. 

Quite  often  there  may  be  a  number  of  small  operations 
which  must  be  performed  on  every  unit  of  the  product. 
To  require  the  worker  to  record  the  time  spent  on  each 
"job"  in  such  cases  is  unnecessary.  All  that  is  necessary 
is  for  him  to  enter  the  production  numbers  of  the  jobs 
he  has  worked  on  and  the  number  of  units  in  each  job. 
The  individual  jobs  or  cost  units  may  be  charged  on  the 
basis  of  a  rate  per  unit  estimated  on  the  basis  of  cost  of 
production.  The  under-  or  over-estimate  may  be  ad- 
justed periodically.  To  illustrate :  In  shoe  manufactur- 
ing, there  is  an  operation  called  "channel  opening"  which 
must  be  performed  on  all  Goodyear  shoes.  A  worker 
receiving  $18.00  per  week  should  be  able  to  handle  2,400 
pairs  of  shoes  a  week  at  a  cost  per  pair  of  ^  of  a  cent. 
If  in  a  certain  week  he  makes  only  2,000  pairs,  included 
in  which  is  lot  number  7,  consisting  of  80  pairs,  lot  num- 
ber 7  would  be  charged  with  60  cents.  The  total  charge 
to  goods  in  process  would  only  account  for  $15.00;  the 
remaining  $3.00  would  be  charged  to  a  Labor  Adjustment 
account.  If  the  production  continued  at  2,000  pairs, 
the  rate  would  be  raised  to  one  cent  per  pair.  Some- 
what similar  is  the  treatment  of  learners  on  piece-work 
operations  who  are  paid  a  guaranteed  minimum-wage. 
The  individual  jobs  are  charged  at  the  usual  piece-rate, 
the  unearned  wage  being  charged  to  an  expense  account 


COST  ACCOUNTING  772, 

such  as  ''Week  Work  Loss."  The  training  of  new  em- 
ployees is  always  expensive;  the  startling  cost  of  such 
training  is  impressed  upon  the  manager  when  he  j,mder- 
takes  to  account  for  every  minute  of  the  time  for  which 
he  is  paying. 

Perhaps  the  most  difficult  problem  is  to  get  time  records 
from  piece  workers.  This  is  necessary  when  the  over- 
head distribution  is  made  on  a  time  basis.  The  week 
worker,  being  paid  for  his  time,  is  not  greatly  concerned 
as  to  how  he  disposes  of  it,  but  the  piece  worker,  who  is 
paid  only  for  what  he  produces,  resents  the  management's 
attempt  to  make  him  do  the  clerical  work  of  recording 
his  time.  The  clerical  work  required  of  piece  workers, 
therefore,  should  be  reduced  to  a  minimum. 

The  distribution  of  overhead. — Overhead,  as  we  have 
seen,  is  composed  of  a  number  of  varied  elements.  The 
problem  before  the  cost  accountant  is  to  distribute  this 
total  of  expenses  over  the  units  of  production  in  such  a 
manner  as  to  "load"  each  unit  with  its  just  share.  This 
distribution  may  be  made  on  any  one  of  a  number  of 
bases,  the  one  chosen  being  that  which  is  best  suited  to 
the  type  or  condition  of  business.  The  main  bases  or 
methods  of  distribution  arc: 

1.  Direct-labor  cost 

2.  Direct-labor  hours 

3.  Prime  cost 

4.  Old  machine-rate 

5.  Fixed  machine-rate 

Direct-labor  cost. — The  theory  of  the  plan  in  which 
direct-labor  cost  is  used  as  the  basis  is  that  there  exists 
a  certain   relation  between  the  total   manufacturing  or 


774  PRINCIPLES  OF  BUSINESS 

factory  overhead  of  a  plant  and  the  total  wages  of  all 
direct  or  productive  laborers;  and  that  the  same  ratio 
holds  between  the  manufacturing  overhead  of  an  "ac- 
counting" or  "statistical''  unit  and  its  direct-labor  cost. 
To  illustrate  :  Suppose  that  the  total  manufacturing  over- 
head is  $15,000,  and  the  total  direct-labor  cost,  $30,000. 
The  ratio  as  computed  is  termed  the  "expense  propor- 
tion," or  "per  cent."  The  ratio  in  the  above  case  would 
be  found  by  dividing  the  manufacturing  overhead  of 
$15,000  by  the  total  direct-labor  cost — $30,000 — giving 
50  per  cent.  This  per  cent  is  applied,  then,  during  the 
cost  period,  by  multiplying  the  direct-labor  cost  of  an 
"accounting  unit"  by  this  per  cent.  For  example,  if  the 
direct-labor  charge  on  a  job  amounts  to  $6,000,  the  manu- 
facturing overhead  for  the  job  would  be  $6,000  X  50 
per  cent,  or  $3,000. 

Advantages  and  disadvantages  of  direct-labor  cost 
method. — The  "direct-labor  cost"  method  is  the  most 
simple  of  all  manufacturmg  overhead  distribution  plans, 
and  for  this  reason  it  is  more  generally  used  than  is  any 
other  method.  It  is  a  satisfactory  method,  if  labor  is 
the  major  element  in  production,  if  the  product  is  uni- 
form in  character,  and  if  the  units  of  product  each  con- 
sume about  the  same  time  in  the  technological  processes. 
Uniformity,  however,  is  rarely  found  except  in  isolated 
departments,  and  the  plan  for  most  concerns  has  serious 
disadvantages.  The  "direct-labor  cost"  method,  how- 
evei,  does  not  require  so  much  clerical  labor  as  the 
"direct-labor  hours"  plan,  or  other  methods  based  on 
time,  since  a  calculation  of  the  labor  time  on  each  unit 
is  not  needed  in  order  to  prorate  the  burden  over  the  jobs. 


COST  ACCOUNTING  77$ 

Direct-labor  hours.^The  "direct-labor  hours"  plan  is 
based  on  the  theory  that  manufacturing  burden  increases 
in  proportion  to  increase  in  the  direct-labor  hours  in  a 
factory.  For  example,  let  us  say  that  the  total  manufac- 
turing overhead  of  a  concern  and  the  total  direct-labor 
hours  for  a  given  period  are  $15,000  and  $30,000,  respec- 
tively. The  overhead  charge  per  direct-labor  hour  would 
be  found  by  dividing  the  overhead  of  $15,000  by  the 
number  of  hours — 30,000 — giving  an  overhead  rate  of 
50  cents  per  direct-labor  hour.  A  current  job  has  taken, 
say,  1,000  direct-labor  hours.  The  manufacturing  over- 
head applicable  to  it  is  1,000  times  $.50,  or  $500. 

The  advantage  of  this  method  over  the  labor-cost 
method  is  that  it  takes  into  consideration  the  element  of 
time.  Many  overhead  items  are  functions  of  time. 
Hence,  any  method  of  overhead  distribution  with  time 
as  a  basis  has  certain  fundamental  advantages.  A  disad- 
vantage, however,  is  that  this  system  involves  the  record- 
ing of  the  labor  hovirs  spent  on  each  job. 

Prime  cost. — Where  prime  cost  is  taken  as  a  basis, 
the  total  of  direct-labor  cost  and  direct-material  cost  is 
used  in  computing  the  burden  ratio — e.g.,  a  total  manu- 
facturing overhead  of  $15,000  divided  by  $50,000,  the 
prime  cost,  equals  30  per  cent.  A  job  with  a  prime  cost 
of  $9,000  would  carry  an  overhead  charge  of  $9,000  X 
30  per  cent,  or  $3,000.  This  plan  is  rarely  used,  and  is 
not  usually  applicable,  unless  the  uniform  conditions  re- 
ferred to  in  connection  with  the  direct-labor  cost  plan 
are  present,  and  unless  the  direct-labor  charges  and  the 
direct-material  charges  are  about  equal  to  each  other  in 
amount. 


776  PRINCIPLES  OF  BUSINESS 

Old  machine-rate. — All  machine  rates  are  based  upon 
the  theory  that  overhead  charges  accumulate  according 
to  the  number  of  running  hours  of  the  machines.  The 
old  machine-rate  is  extremely  simple  to  compute  and 
apply.  The  manufacturing  overhead  is  ascertained  for 
a  stipulated  period ;  this  is  divided  by  the  sum  of  the  hours 
the  machines  have  been  running  during  this  period,  and 
the  result  is  the  old  machine-rate.  In  order  to  ascertain 
the  proportion  of  the  manufacturing  overhead  attribu- 
table to  any  given  product,  this  rate  is  multiplied  by  the 
number  of  hours  the  product  has  been  in  process.  The 
method  is  suitable,  under  certain  conditions,  for  use  in 
a  single  department,  but  is  rarely  applicable  to  the  shop 
as  a  whole.  This  is  true  because  it  is  not  applicable  un- 
less such  conditions  are  present  as  uniform  original  cost^ 
uniform  installation  charges,  uniform  subsequent  addi- 
tions to  the  machines,  uniform  absorption  of  heat,  light, 
power,  and  the  like.  It  can  readily  be  seen  that  such  a 
uniformity  of  conditions  will  seldom  be  found. 

Fixed  machine-rate. — The  fixed  machine-rate  method 
is  more  complicated  than  the  old  machine-rate.  The  en- 
tire factory  is  divided  up  into  production  centers — a  pro- 
duction center  being  a  department  or  a  subdepartment 
where  there  exists  a  uniformity  of  manufacturing  condi- 
tions. A  production  center  may  be  an  assembly  space,  a 
workbench,  a  machine,  or  a  group  of  machines.  The 
manufacturing  overhead  for  the  entire  factory  for  the 
following  fiscal  period  is  then  estimated.  This  estimate 
is  based  on  past  figures,  present  facts  and  future  policies, 
and  should  be  prepared  by  a  committee  of  the  factory  and 
general  executives. 


COST   ACCOUNTING  777 

The  overhead  estimate  is  made  in  detail,  and  each  item 
of  expense  is  prorated  over  the  production  centers  on  a 
suitable  basis,  as  will  be  explained  later.  The  total  of 
the  expenses  allocated  to  each  production  center  is  then 
divided  by  the  number  of  machines  in  the  center,  giving 
the  total  overhead  chargeable  to  each  machine  for  the 
entire  fiscal  period.  This  amount  is  divided  by  the  stand- 
ard number  of  working-hours  in  the  fiscal  period,  giving 
the  .overhead  charge  for  the  operation  of  each  machine 
in  the  production  center  for  one  hour. 

The  calculated  hourly  machine-rate  is  then  applied  as 
follows:  The  number  of  hours  which  a  given  job  con- 
sumes in  passing  through  a  production  center  is  deter- 
mined, and  the  number  of  hours  is  multiplied  by  the 
machine-hour  rate  for  that  center,  giving  the  manufactur- 
ing overhead  chargeable  to  the  job  while  passing  through 
the  given  center. 

If  the  machines  do  not  run  during  all  of  the  normal 
operating  period,  the  charges  to  the  individual  jobs  will 
not  absorb  the  entire  amount  of  estimated  overhead.  This 
unabsorbed  overhead,  or  "unearned  burden,"  is  distrib- 
uted over  the  entire  product  by  a  supplementary  rate 
based  on  the  total  number  of  direct-labor  hours  for  the 
period.  The  supplementary  charge  to  each  job  is  ob- 
tained b}^  multiplying  the  total  number  of  direct-labor 
hours  on  the  job  by  the  above-mentioned  supplementary 
rate. 

The  following  overhead  distribution  chart  will  show 
the  method  of  arriving  at  the  machine-hour  rate  and  the 
proper  basis  for  the  apportioning  of  the  various  items  of 
expense. 


77^ 


PRINCIPLES  OF  BUSINESS 


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COST  ACCOUNTING  779 

Administrative  charges  applicable  to  the  factory. — 

Administrative  charges  applicable  to  the  factory  may  be 
distributed  over  the  production  centers  by  one  of  three 
ways : 

I.  According  to  the  approximate  time  spent  by  the  ad- 
ministrative officials  in  each  production  center; 

2  According  to  the  direct-labor  hours,  estimated  for 
each  production  center; 

3.  According  to  the  number  of  laborers  in  each  depart- 
ment. 

Suppose  that  the  only  administrative  charge  is  that  of 
the  superintendent,  who  gets  $2,400,  spending  three- 
fourths  of  his  time  in  the  general  office,  one-fourth  in  the 
factory,  and  an  equal  amount  of  this  one- fourth  in  each 
of  six  production  centers.  One-fourth  of  his  salary,  or 
$600,  should  be  borne  by  the  factory,  and  one-sixth  of 
this  by  each  production  center,  provided  the  salary  is 
prorated,  according  to  the  time  spent  by  the  superin- 
tendent in  each  center. 

Depreciation. — Depreciation  can  be  closely  estimated 
if  the  concern  has  kept  a  plant  ledger.  The  figures  in 
the  table  are  arbitrary. 

Indirect  labor. — Indirect  labor  may  consist  of  the 
labor  charges  of  department  heads,  foremen,  cost  clerks, 
sweepers,  inspectors,  etc.  Such  items  may  be  charged 
directly — e.g.,  if  a  foreman  is  employed  in  only  one  pro- 
duction center,  his  wage  can  be  charged  directly  to  the 
center;  or,  if  he  works  in  several  centers,  his  wages  can 
be  prorated  over  these  centers,  according  to  the  number 
of  men  under  him  in  each  department.  The  wages  of 
truck  handlers  may  be  distributed  over  production  centers 


;-8o  PRINCIPLES  OF  BUSINESS 

according  to  the  volume  of  product  handled  for  each 
center;  the  wages  of  sweepers  according  to  the  floor  space 
of  the  centers.  Again,  arbitrary  figures  are  entered  in 
the  table  for  indirect  labor. 

Heat. — The  item  of  "heat"  may  be  loaded  onto  the 
various  production  centers  on  the  basis  of  their  respective 
dimensions  in  cubic  or  square  yards  or  feet.  The  heat 
cost  in  this  problem  is  $300  for  a  floor  space  of  4,000 
square  feet.  The  charge  per  square  foot  is  $.75,  to  be 
borne  by  each  center  appearing  in  the  table  as  follows: 
Center  i — 1,000  square  feet;  center  2 — 900  square  feet; 
center  3 — 300  square  feet;  center  4 — 400  square  feet; 
center  5 — 500  square  feet;  center  6 — 900  square  feet. 

Light. — If  gas  meters  are  maintained  in  each  center 
the  unit  of  measurement  and  distribution  for  the  lighting 
charge  is  the  cubic  foot  of  gas.  If  the  plant  is  lighted  by 
electricity,  and  meters  are  used,  the  unit  for  measure- 
ment and  distribution  is  the  kilowatt  hour.  If  there  are 
no  meters  of  any  kind  in  the  establishment,  the  square 
foot  of  floor  space  may  serve  as  the  unit  of  allocation  of 
the  light  charges.  Let  us  use  the  latter.  Since  the 
amounts  of  the  total  light  bill  and  the  total  heat  bill  are 
equal,  and  since  the  methods  of  distribution  are  the 
same,  the  charges  to  light  against  each  production  center 
will  be  the  same  as  the  charges  to  heat. 

Insurance. — It  may  be  possible  to  charge  a  part  of  the 
insurance  directly  to  production  centers,  if  policies  are 
taken  out  specifically  on  values  in  the  individual  centers. 
Otherwise,  the  allocation  of  insurance  is  made  accord- 
ing to  the  respective  values  in  the  centers.  Although 
floor  dimensions  in  square  feet  may  sometimes  serve  as 


COST   ACCOUNTING  781 

the  basis  of  the  distribution  of  insurance  charges,  this 
basis  is  obviously  inequitable,  because  the  values  in  the 
centers  do  not  necessarily  vary  according  to  the  areas. 
Here  again,  it  is  necessary  to  insert  arbitrary  figures  in 
the  table. 

Indirect  materials. — The  nature  and  rate  of  consump- 
tion of  "indirect  material"  being  known,  its  approximate 
cost  for  the  next  period  may  be  estimated.  There  is  no 
special  rule  to  guide  one  in  spending  this  charge  over  the 
production  centers.  Where  there  is  no  special  rule,  the 
overhead  is  said  to  be  dissected  according  to  special  allot- 
ment. 

Power. — The  charge  for  power  is  spread  over  the  cen- 
ters according  to  the  estimated  horse-power  hours  or 
kilowatt  hours  to  be  consumed  by  each  center. 

Rent. — The  amount  of  floor  space  in  square  feet  is 
the  basis  for  the  prorating  of  rent.  Sometimes  the  rela- 
tive values  of  floor  space  are  also  considered — e.g.,  in 
department  stores  the  lower  floor  space  is  more  valuable 
than  that  of  upper  floors,  and  side  aisles  are  less  valuable 
than  the  main  aisles. 

Repairs  and  maintenance. — Costs  of  repairs  and 
maintenance  may  be  a  part  of  the  total  depreciation 
charge,  or  they  may  be  segregated.  If  a  concern  is  of  any 
size  it  will  probably  maintain  a  repair  department  which 
will  perform  both  repair  work  and  "construction  work. 
The  material,  labor  and  overhead  charges  for  this  repair 
department  are  estimated.  The  prospective  construction- 
work  charges  are  subtracted  from  the  total  charges,  and 
the  difference  is  distributed  to  the  centers.  To  find  the 
percentage,  the  estimated  repair  and  maintenance  charges 


782  PRINCIPLES  OF  BUSINESS 

for  each  center  are  divided  by  a  sum  representing  the 
total  valuation  of  the  buildings  and  equipment. 

This  per  cent  is  then  applied  to  the  values  of  buildings 
and  equipment  in  each  production  center  to  get  an  esti- 
mated repair  and  maintenance  charge  for  that  center  for 
the  ensuing  period. 

Taxes. — The  best  way  to  prorate  the  charge  for  taxes 
is  according  to  the  assessed  values  in  the  centers,  rather 
than  on  the  basis  of  book  values  of  the  respective  centers 
or  on  that  of  their  floor  space. 

Interest. — The  item  of  interest  is  dissected  on  the 
basis  of  book  values  rather  than  on  that  of  insured  values. 
If  interest  is  not  regarded  as  a  part  of  manufacturing 
overhead,  it  should  not  be  considered  in  computing  the 
fixed  machine-rate. 

Standard  labor  hours. — The  normal  number  of  work- 
ing hours  for  a  year  may  be  found  by  multiplying  the 
standard  number  of  hours  per  week,  48,  49,  or  55,  by  52 
(the  number  of  weeks  in  a  year)  and  then  subtracting  an 
allowance  for  from  10  to  12  holidays.  The  estimate  of 
2,400  hours,  used  in  the  table,  is  based  on  a  48-hour 
week  with  an  allowance  for  12  holidays. 

Idle  time  or  "unearned  burden." — In  businesses 
chiefly  of  a  seasonal  nature,  the  problem  of  idle  time  or 
"unearned  burden"  is  of  considerable  importance.  That 
part  of  the  overhead  which  is  a  function  of  time  accumu-» 
lates  when  the  plant  is  idle,  and  consequently  there  is  no 
product  to  which  such  overhead  can  be  charged. 

Idle  time  may  be  charged  ( i )  to  manufacturing  cost, 
through  the  medium  of  a  supplementary  rate,  as  explained 
in  connection  with  the  handling  of  a  fixed  machine-rate. 


COST   ACCOUNTING  783 

It  has  been  said  that  the  ratio  of  the  supplementary  rate 
to  the  fixed  machine-rate  forms  a  sort  of  barometer  the 
movements  of  which  are  an  index  of  factory  efficiency. 
If  the  supplementary  rate  is  increasing  disproportionately 
to  the  increase  in  the  fixed  machine-rates,  then  efficiency 
is  decreasing.  If  this  method  of  absorbing  idle  time  is 
used,  the  costs,  according  to  the  records,  will  seem  high 
when  production  is  low,  and  low  when  production  is  high. 
This  is  so  because  in  the  latter  case  there  are  more  units 
of  output  than  in  the  former  over  which  to  prorate  the 
burden.  This  results  in  a  considerable  fluctuation  in  the 
costs  as  between  a  busy  and  a  dull  season,  and  at  such 
times  in  the  business  cycle  comparative  costs  are  not  very 
helpful  in  the  disentangling  of  business  problems. 

The  reason  for  charging  unearned  burden  to  the  fac- 
tory is  that  the  factory  is  "responsible."  Idle  time,  how- 
ever, may  be  due  not  to  faulty  production  or  to  inferior 
quality  of  output,  but  to  the  inefficiency  of  the  sales  de- 
partment, which  may  not  be  securing  enough  orders  to 
keep  the  plant  running.  Hence,  idle  time  may  be  charged 
(2)  not  to  the  factory  but  to  the  sales  department. 

Both  the  production  and  the  selling  divisions  of  the 
company's  organization  may  be  partially  to  blame  for 
the  idle  time,  which  in  such  a  case  may  be  charged  (3) 
against  both  of  these  departments.  How  much  should 
then  be  charged  to  each  is  a  very  difficult  question  to  de- 
cide. 

Idle  time,  again,  in  the  opinion  of  some  accountants, 
should  be  charged  neither  to  the  factory  nor  to  the  sales 
department,  but  (4)  should  be  treated  in  one  of  the  fol- 
lowing two  ways : 


784  PRINCIPLES  OF  BUSINESS 

(a)  Debited  directly  to  the  profit  and  loss  acount  in 
the  period  of  its  occurrence;  or 

(b)  Charged  against  a  "reserve  for  unearned  burden" 
which  has  been  built  up  out  of  large  profits  in  busy  sea- 
sons. The  latter  course  is  most  often  taken  when  the 
idle  time  is  excessive. 

The  feeling  of  the  writer  is  that  the  tracing  of  direct 
responsibility  for  idle  time  is  a  difficult  task,  and  that  in 
a  majority  of  cases  both  the  production  and  selling  de- 
partments, as  -well  as  uncontrollable  business  conditions, 
are  to  blame. 

Cost  records  and  general  books. — The  records  and 
methods  used  in  determining  the  amount  of  materials, 
labor  and  overhead  applicable  to  each  unit  of  production 
have  been  explained  and  described.  All  that  now  re- 
mains is  to  explain  how  the  three  elements — materials, 
labor  and  overhead — are  brought  together,  in  order  that 
it  may  be  seen  how  the  total  cost  of  all  units  agrees  with 
the  total  cost  of  production  as  shown  by  the  general 
books. 

The  production  order  and  the  cost  sheet. — Before 
we  can  obtain  any  information  as  to  the  cost  of  produc- 
tion of  a  given  unit  the  unit  must  be  identified,  so  that 
all  material  and  labor  expended  in  its  manufacture  may 
be  charged  to  it.  A  production  order,  bearing  a  number 
and  a  full  description  of  the  goods  included  under  the 
order,  should  be  made  out  for  each  unit  of  production 
before  it  is  put  into  work.  The  order  should  be  made 
out  in  duplicate,  one  copy  going  to  the  factory  and  one  re- 
maining in  the  office.  Additional  copies  may  be  made 
out  if  work  on  "job"  is  started  in  several  places  in  the 


COST  ACCOUNTING  785 

factory.  To  the  office  copy  is  usually  attached  the  cost 
sheet,  although  the  latter  may  be  separate.  The  produc- 
tion order  follows  the  work  through  the  plant,  and  all 
labor  and  material  used  are  charged  to  the  order  number. 
If  a  coupon  system  of  paying  piece  workers  is  used,  the 
coupons  may  form  a  part  of  the  production  order. 

The  forms  of  cost  sheets  vary  greatly.  The  essentials 
are:  the  order  number;  sufficient  description  to  identify 
the  product;  and  spaces  for  the  entering  of  materials, 
labor  and  overhead.  The  arrangement  depends  upon  the 
number  of  operations,  method  of  payment  of  labor,  and 
the  method  of  distributing  overhead. 

On  the  following  page  is  an  illustration  of  a  simple 
production-order  and  cost  sheet,  designed  to  record  labor 
paid  on  a  piece-work  basis  and  providing  for  the  dis- 
tribution of  overhead  as  a  percentage  of  the  direct-labor 
cost. 


786 


PRINCIPLES  OF  BUSINESS 


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COST  ACCOUNTING 


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788  PRINCIPLES  OF  BUSINESS 

General  -  ledger  accounts. — On  the  following  page 
will  be  found  a  chart  of  the  general-ledger  accounts  which 
are  affected  by  the  cost  system,  together  with  a  statement 
of  the  circumstances  under  which  each  account  is  debited 
or  credited.  This  arrangement  is  consistent  with  the 
primary  purpose  or  function  of  a  system  of  cost  account- 
ing, which  is  to  show  the  profit  or  loss  resulting  from 
the  operations  of  the  business  as  a  whole,  and  also  the 
profit  or  loss  on  each  unit.  The  profit  or  loss  of  the  busi- 
ness as  a  whole  is  shown  invariably  by  the  difference  be- 
tween the  debit  balance  in  the  "cost  of  goods  sold" 
account,  and  the  credit  balance  in  the  "sales  account." 
The  details  of  this  profit  or  loss  may  be  found  by  listing 
each  sale  and  setting  against  it  the  cost  of  the  goods  sold, 
as  taken  from  the  credit  side  of  the  finished-stock  cards. 
This  may  be  done  at  the  time  of  entering  the  sale  by 
providing  an  extra  column  in  the  sales  book  for  enter- 
ing the  cost  of  each  item.  This  is  a  convenient  method 
of  arriving  at  the  total  cost  of  goods  sold  each  month. 
Various  uses  may  be  made  of  this  information,  among 
which  uses  are  the  determining  of  the  profit  or  loss  on 
each  customer's  account  and  the  determining  of  the  profit 
or  loss  on  the  product  sold  by  each  salesman. 

MATERIALS 

Credited  with  amomit  of  ma- 
terials issued,  from  daily,  week- 
ly or  monthly  totals  of  requisi- 
tion. 


Debited  with  inventory  at  the 
beginning   of    the    period. 

Debited  with  materials  pur- 
chased. 

Balance  indicates  the  amount 
of  material  on  hand  and  should 
agree  with  the  total  balances  of 
the  stock  cards. 


COST  ACCOUNTING 


789 


PAYROLL 


Debited  with  the  actual 
amount  of  cash  paid,  as  shown 
by    cash    book. 


Credited  with  the  toial  amount 
of  the  payroll  for  both  direct 
and  indirect  labor. 

Balance  represents  the  amount 
of  unpaid  labor. 


WORK  IN  PROCESS 


Debited  with  inventory  of 
goods  in  process  at  beginning 
of  period. 

Debited  with  amount  of  direct 
labor  payroll. 

Debited  with  amount  of  mate- 
rials used  from  total  of  requisi- 
tions. 

Debited  with  amount  of  over- 
head distributed  as  shown  by 
the  machine  hour  summary. 

Balance  represents  the  value 
of  goods  in  process  of  manu- 
facture and  should  agree  with 
the  total  cost  of  all  jobs  in 
process  as  shown  by  the  cost 
ledger. 


Credited  with  the  amount  of 
work  completed  and  transferred 
to   finished   stock. 


FACTORY  EXPENSE 


Debited  at  end  of  fiscal  period 
with  the  total  of  all  expenses 
forming  part  of  the  factory 
overhead  by  transfer  from  the 
various  expense  accounts. 

A  debit  balance  indicates  an 
under-estimate  of  the  amount 
of  overhead.  The  balance  may 
be  carried  forward  to  the  next 
fiscal  period,  or  disposed  of — 
either  by  closing  out  to  Profit 
and  Loss,  or  as  an  offset  to  an 
opposing  balance  in  the  over- 
head   accouut 


Credited  at  beginning  of 
period  with  estimated  amount 
of  overhead  for  the  fiscal 
period. 


A  credit  balance  indicates  an 
over-estimate  of  the  amount  of 
overhead.  The  balance  may  be 
carried  forward  to  the  next 
fiscal  period  or  disposed  of — 
either  by  closing  out  to  Profit 
and  Loss  or  as  an  offset  to  an 
opposing  balance  in  the  over- 
head account. 


790 


PRINCIPLES  OF  BUSINESS 


OVERHEAD 


Debited  at  beginning  of  period 
with  estimated  amount  of  over- 
head for  the  fiscal  period. 


There  will  not  ordinarily  be 
a  debit  balance,  as  the  unab- 
sorbed  overhead  is  distributed 
by  the  supplementary  rate.  If 
the  factory  expense  appears  to 
have  been  over-estimated  the  un- 
distributed overhead  may  be 
used  to  ofifset  such  over-esti- 
mate. 


Credited  from  machine  sum- 
maries with  the  amount  of  over- 
head distributed  to  goods  in 
process. 

Credited  with  amount  of  over- 
head distributed  to  goods  in 
process  by  a  supplementary  rate 
(if   any). 

A  credit  balance  indicates  that 
the  number  of  machine  hours 
has  exceeded  the  normal 
amount.  This  is  usually  ac- 
companied by  an  increase  in  the 
amount  of  expense  over  the  esti- 
mate, in  which  event  the  bal- 
ances are  offset  against  one 
another. 


FINISHED  GOODS  STOCK 


Debited  with  inventory  of 
finished  goods  at  beginning  of 
period. 

Debited  with  work  completed 
at    cost    shown    by    cost    ledger. 

Debited  with  returned  sales  at 
cost. 

Balance  represents  the  amount 
of  finished  goods  on  hand  and 
must  agree  with  the  total  bal- 
ance of  the  finished  stock  cards. 


Credited  with  goods  sold    (at 
cost). 


COST  OF  GOODS   SOLD 


Debited  with  the  cost  of  goods 
sold. 

The  balance  of  this  account 
shows  the  cost  of  net  sales. 
The  difference  between  this  bal- 
ance and  the  net  sales  repre- 
sent the  profit  on  sales.  At 
the  end  of  the  period  the  bal- 
ance is  closed  out  either  to 
-sales  or  to  Profit  and  Loss. 


Credited    with   cost   of   goods 
returned. 


COST  ACCOUNTING  791 

Cost-controlling  accounts. — It  should  be  noticed  also 
that  three  new  controlling  accounts  have  been  created, 
namely,  Materials,  Work  in  Process  and  Finished  Goods. 
The  balance  of  the  Materials  account  always  represents 
the  amount  of  materials  on  hand,  valued  at  cost.  It 
should  always  agree  with  the  total  of  the  balances  of  the 
stock  sheets  or  stock  cards,  which  form  a  subsidiary 
ledger  called  the  Materials  or  Stock  Ledger.  The  Work 
in  Process  account  indicates  the  total  amount  of  material, 
labor  and  manufacturing  overhead  expended  on  uncom- 
pleted work.  The  balance  of  this  account  must  agree 
with  the  total  charges  on  the  cost  sheets  of  the  jobs  in 
process.  The  debits  to  the  Work  in  Process  account, 
which  are  for  material,  labor  and  manufacturing  over- 
head, must,  of  course,  agree  with  the  total  of  the  charges, 
for  these  items  to  the  individual  jobs  or  other  "units."" 
The  total  amount  of  materials  used  is  obtained  by  total- 
ling the  amounts  of  the  material  requisitions  periodically.. 
The  total  labor  is  found  by  adding  up  the  job  tickets, 
piece-work  coupons,  or  time  tickets.  Attention  has  been 
called  to  the  fact  that  the  total  credit  to  payroll  for 
direct  labor  may  be  greater  than  the  debit  for  labor  to 
work  in  process,  the  balance  of  the  entry  consisting  of 
charges  to  such  expense  accounts  as  Idle  Time,  Week 
Work  Loss,  etc.  Where  the  machine-hour  method  of 
distributing  the  manufacturing  overhead  is  used,  the  total 
amount  of  burden  entered  on  the  cost  sheets  may  be  found 
by  sorting  the  time  cards  by  production  centers  and  multi- 
plying the  total  number  of  hours  in  each  center  by  the 
proper  machine-hour  rates,  as  in  the  following  machine- 
hour  summary: 


792 


PRINCIPLES  OF  BUSINESS 
MACHINE-HOUR  SUMMARY 


DAY 

PRODUCTION  CENTER 

I 

2 

3 

4 

S 

M 
T 
W 
TH 
F 
S 

i6 

i8 

15 

18 

18 

6 

27 
27 
27 
27 
20 
9 

16 
18 
18 
18 
18 
6 

18 
18 
18 
16 
18 
6 

ON  00  00  00  00  00 

TOTAL 

91 

137 

94 

94 

96 

RATE 

^0.12 

$0.11 

$0.13 

$0.14 

$10.00 

OVER- 
HEAD 

$10.92 

5515.07 

$12.22 

$13.16 

$9.60 

TOTAL  OVERHEAD 

$60.97 

As  soon  as  the  last  process  is  entered  on  the  cost  sheet 
of  a  job,  it  is  taken  from  the  "in  work"  file  or  binder. 
The  number  of  units,  cost  per  unit  and  total  cost  of  the 
job  are  entered  on  the  finished-stock  cards.  The  cost  of 
the  finished  jobs  is  totalled  weekly  or  monthly,  and  a 
journal  entry  is  made  debiting  Finished  Goods  Stock  and 
crediting  Work  in  Process.  The  cost  sheets  are  then 
filed  for  future  reference.  The  Finished-goods  Stock, 
the  third  controlling  account,  must  always  agree  with  the 
total  of  the  balances  on  the  finished-stock  cards. 

The  advantage  of  these  three  controlling  accounts  is 
apparent.  They  indicate  at  all  times  the  amount  of  the 
total  inventory,  classified  as  to  Materials,  Work  in  Proc- 
ess, and  Finished  Stock,  each  class  being  further  ana- 
lyzed in  the  subsidiary  records.  This  information  is 
especially  valuable  in  the  event  of  loss  by  fire  or  theft. 


COST  ACCOUNTING  793 

General  overhead. — ^Up  to  this  point  nothing  has  been 
said  about  "general  overhead"  except  to  distinguish  it 
from  "factory  overhead."  The  general  overhead  must 
be  added  to  the  cost  of  manufacturing  before  the  total 
cost  can  be  determined.  Nevertheless,  it  is  not  custom- 
ary to  make  any  entry  of  it  upon  the  cost  sheets,  the  Cost- 
of-goods-sold  account  representing,  as  we  have  seen,  the 
manufacturing  cost.  The  difference  between  the  Cost- 
of-gocds-sold  account  and  the  Sales  account  is  the  profit 
on  sales,  and  from  this  difference  the  selling  and  admin- 
istrative expenses  must  be  deducted  in  order  to  show  the 
amount  of  the  net  profit. 

Cost  records  in  their  relation  to  the  selling  price. — 
In  calculating  the  selling  price,  an  allowance  is  made  for 
general  overhead  as  a  certain  percentage  of  the  sales 
price,  the  percentage  being  based  on  the  past  experience  of 
the  business.  Thus,  if  the  sales  for  the  previous  year 
were  $1,000,000  and  the  general  overhead  $80,000,  the 
overhead  for  the  succeeding  period  would  be  figured  at 
8  per  cent. 

In  order  to  ascertain  the  proper  selling  price,  there 
must  be  added  to  the  factory  cost  the  general  overhead, 
and  an  allowance  for  the  desired  profit.  As  both  of  these 
percentages  are  based  on  the  unknown  selling  price,  we 
must  draw  upon  our  knowledge  of  arithmetic  to  solve  the 
problem. 

If  we  call  our  desired  selling  price  100  per  cent,  we 
must  subtract  8  per  cent  for  overhead,  and,  let  us  say, 
5  per  cent  for  profit — a  total  of  13  per  cent.  Our  cost, 
then,  must  be  87  per  cent  of  the  selling  price.  If  the  cost 
is  $1.00,  the  selling  price  is  to  be  $1.00-^87  or  $I-I5. 


794  PRINCIPLES  OF  BUSINESS 

The  general  overhead  is  sometimes  figured  as  a  per- 
centage of  the  manufacturing  cost,  the  result  l^eing  prac- 
tically the  same  as  when  it  is  calculated  by  the  percentage- 
of-sales  method. 

Essentials  of  cost  forms. — It  has  not  been  possible 
within  the  limits  of  this  chapter  to  present  a  complete  set 
of  the  forms  used  in  a  cost  system.  Very  little,  if  any- 
thing, has  been  lost  by  their  omission.  A  cost  system 
does  not,  as  so  many  seem  to  assume,  consist  merely  of 
a  number  of  forms.  A  cost  system  is  an  application  of 
the  principles  of  cost  accounting  to  a  particular  business. 
In  devising  forms,  the  main  things  to  be  considered  are 
the  information  the  form  should  furnish,  where  the  in- 
formation is  to  be  obtained,  and  what  disposition  is  to  be 
made  of  the  information.  If  the  form  contains  pro- 
visions for  entering  the  necessary  information  in  a  man- 
ner convenient  to  the  person  who  must  furnish  the 
information,  the  selection  of  the  size  and  arrangement  of 
the  form  will  be  a  comparatively  simple  matter. 

BIBLIOGRAPHY 

Maxey,  E.  P.,  Principles  of  Factory  Cost  Keeping. 
Picker,  N.  T.,  Industrial  Cost  finding. 
Nicholson,  J.  L.,  Cost  Accounting — Theory  and  Practice. 
Church,  A.  H.,  Manufacturing  Costs  and  Accounts. 
Wood,   C.   E.,   Uniform  Accou)iting  AJethods  for  Industrials. 
W'ebner,  P.  E.,  Factory  Accounting. 
Wildman,  J.  R.,  Principles  of  Cost  Accounting. 
Bunnell,  S.  H.,  Cost-Keeping  for  Manufacturing  rinnts. 
Evans,  H.  A.,  Cost-Keeping  and  Scientific  Management. 
Scovell,  C.  H.,  Cost  Accounting  and  Burden  Application. 
Church,  A.  H.,  Production  Factors. 
Church,  A.  H.,  E.x-pense  Burden. 
Picker.  N.  T.,  Shop  E.rpensc  Analysis  and  Control. 
Pranklin,  B.  J.,  Cost  Reports  for  E.vecutives. 
Eggleston,  D.  C,  Cost  Problems  and  Solutions. 
Parkhurst,  P.  A.,  Predetermination  of  True  Costs  and  Relatively 
True  Selling  Prices. 


INDEX 


Acceptance  bills,  665 
Acceptance  credits,  652 
Acceptances,  545,  620,  647 

advantages  of,   546 

bankers',    defined,    652 

bankers'    domestic,    645 

as   collateral    for   Federal   Re- 
serve notes,  640 

as  credit  instruments,  539 

drawn    to    furnish    dollar    ex- 
change,  645 

in  open-market  operations,  657 

trade,  defined,  647 
Accommodation   paper,   620 
Account,  bookkeeping,  how  created, 
689 

capital,  736 

donation,   730 

equipment,   725 

findings,  759 

general  ledger,  788 

machinery,  706,  725 

merchandise,  690 

nominal,   690,   699 

revenue,    699 

trading,  692 
Accounting    (chapters),   684,  754 

defined,   6,   684 

department,  214;  chart  of,  215 

depreciation  allowances  in,  705 

history  of,   686 

principles,   699 

system,  checks  on,  695 
Accounting  or   statistical    unit,   774 
Accounting    system,    defined,    695 
Accounts,   book,    539,    540 

books  of,  694 

controlling,   696;    defined,   697 

I.  C.  C.  classification  of,  loi 

"mixed,"  691 

payable,  698 

payable,  defined,  737 


Accounts,   real,  690,  699 
renewed,  735 

Accounts    receivable,     in     financial 
statements,  732 

relation  to  sales,  744 

Action,  psychology  of,  in   advertis- 
ing, 410 

in  salesmanship,  447 

Adams,    Brook,    "Theory   of    Social 
Revolutions,"   56 

Addressing,    standards    of    output, 
249 

Adjustability  of  currency,  633 

Administration,   7 

Administrative  charges,  779 

Administrative    expenses,     defined, 

749.    758 
Advances    to    salesmen,    shown    in 

financial  statements,  732 
Advertising    (chapter),  400 
as  a  business  force,  87 
cost  of,  422 

distinguished    from    salesman- 
ship, 440 
expenses  in  accounting,  735 
financial,    156 

package  as  medium  of,  429 
Advertising    department,    214 
Affiliated  corporations,  753 
Agencies,   selling,  463 
Agreements,   creditors',    568 
Agreements,   syndicate,    153 
Agricultural  credit,  611 
Agricultural   paper,   defined,   651 

eligibility   of,   644 
Agricultural     production    as    influ- 
ence in  business  changes,   579 
Allocation  of  expenses,  in  cost   ac- 
counting,  761 
Amalgamated     Clothing    Workers, 

314 
Amalgamation,    116 
American    Academy,    Annals,    347, 
355,   357 


795 


796 


INDEX 


American  Association  of  Financial 

Statisticians,    114 
American  Bankers  Association,  651 
American  Trade  Acceptance  Coun- 
cil,  647 
Amortization  of  patent  values,  729 
Analysis  of  balance  sheet,  741 
Analysis,    basis    of    scientific   man- 
agement,  93 
Analysis  of   business  problems,   87, 

90 
Analysis  of  human  elements  in  or- 
ganization,  217 
Analysis  of  market,  433,  452 
Analysis  of  records,  220 
Annuity,  present  value  of,  723 
Anticipation  of  income,  703 
Application    for    Federal    Reserve 

notes,  640 
Approach,   in  salesmanship,  443 
Arbitrageur,  methods  of,  676 
Arbitraging,  675 
Arbitrary    interest  charges,   in  cost 

accounting,  764 
Arbitration,  board  of,  314 
Area   theory,   Babson's,   583 
Argentina,  standard  coin  of,  669 
Argument    and    suggestion,    450 
Assembling,  step  in  promotion,   125 
Asset   account,   in  bookkeeping,  688 
Asset,   defined,    700,   702 
Assets,    current,    704;    defined,    730 

fixed,  704 
Assets  and  liabilities,  statement  of, 

716 
Assets,  intangible,  727 
Assets,    over-valuation    of,    730 
revaluation    of,    738 
service-life  of,  707 
valuation  of,   704 
wasting,  724 

working   and   trading,    733 
Association  of  Governmental  Labor 
Officials  of  U.  S.  &  Canada,  282 
Associations  formed  under  deeds  of 

trust,   109 
Associations,  merchants',   563 
Attention,    psychology-    of,    68,    404, 

444 
Attorneys,  credit  information  f-om, 
564 


Authority,    for    acceptance   of   staff 

recommendations,   196 
Authority,  managerial,   190,  216 

B 

Babcock,  George  D.,  302 
Babson,  Statistical  Service,  16 
Bad-debt  losses,  insurance  against, 
569 

reserves    against,    510 
Bad  debts,  recoveries  on,  751 

factor  in  selling  cost,  418 
"Bad-pay"    customers,    information 
concerning,  563 

collecting  from,   566 
Bailee  receipt,  specimen,  552 
Balance    sheet,    specimen,   719 
Balance  sheets,  716,  717,  741 

in   bookkeeping,   692 

defined,   716 

form  of,  718 

interpretation   of,    739 

items    appearing   on,    718 

represent  estimated  values,  721 
Balance-of-stores  clerk,  211 
Balance  of  trade,  504,  670,  674,  675 
Balance,  trial,  695,  696 
Bank  acceptances,  limitations  upon 

rediscounts  of,   647 
Bank  clearings  index,  91 
Bank  deposit,  nature  of,  593 
Bank  discounts,  defined,  643 
Bank    drafts,    544,    663 

in    domestic    and    foreign    ex- 
change, 662 
Bank   notes.    Federal    Reserve,    638 

retirement   of,    638 
Bank    statements,    720 
Bank  stocks,   why   profitable,    595 
Bankable    proposition,    defined,    623 
Bankers'  acceptances,  547,  652 

collateral  for  reserve  notes,  640 

defined,    652 

to  furnish  dollar  exchange,  652 

in  open-market  operations,  657 

substitution     of    collateral     se- 
curing,   653 
"Bankers'  banks,"  604 
Bankers'  bills  of  exchange,  666 
Bankers'  domestic  acceptances,  64'; 
653 


INDEX 


797 


Bankers'    foreign    acceptances,    645 
Bankers,    investment,    functions   of, 

608 
Bankers'     long    bills,     666;     short 

bills,  666 
Banking    (chapters),   585,   631 
Banking   credit,    553 ;    defined,    555 
Banking   laws,   626 
Banking,   origin   of,    595 
Bankruptcy,   170 

concerns   exempt   from,    177 
procedure  in,  175 
Bankruptcy   petitions,  when  to  file, 

567 

Banks,  classes  of,  603 

Banks,  credit  information  from,  564 
economic  services  of,   585 
facilities    of,    for   credit   exten- 
sion,  592 
facilities     of,     for     credit     ex- 
change,  593 
paternalistic  attitude  of,  601 
profits,   how   made,   594 
reserves    against    deposits,    636 
rural  credit  banks,  606,  611 

Banks,    savings,    606 

strength  of  different  classes  of, 
627 

Banks'  credit,  basis  of,  597 

Bargaining,    collective,    314;    indi- 
vidual,   315 

Bargaining,    process  of,   8 
in    purchasing,    390 

Barometers  of  business  profits,  581 
composite,    583 
of    distribution,    580 
of  the   exchanges,   582 
of   labor  conditions,    581. 
of  the  money  market,  582 
of    production,    579 

Barometrics    of    business,    16,    570, 

573 
Barter,  9 

Base    wage,    302,    308 
Basic   departments,    208 
"Bearer"   bonds,    542 
"Beating  the  management,"  294 
Berlin,  exchange  on,  674 
Bills  of  exchange,  516,  539 
acceptance,   665 
bankers',   664 


Bills  of  exchange,  classes  of,  663, 
664 

clean,    664 

commercial,   664 

defined,   544,   646 

documented,   665 

domestic,   663 

eligible    for   purchase  tin  .open 
market,    657 

factors  in  prices  of,  668 

foreign,  664 

payment,   665 

specimen,   664 
Bill    of   lading,   498,    516,    517 

in  foreign  exchange,  665 
Bill  of  materials,  766 
Bills  receivable,   731 
Block  and  zone  system,  I.  C.  C,  501 
"Blue  sky"   legislation,   156,   535 
Blythe,   Samuel   G.,  449 
Bond  circular,    153 
Bond  issues,  financing  through,  136 
Bonded   warehouse    system,    531 
Bonds,  539 

choice  of,    136 

classes    of,    541 

debenture,    137,    139 

discount  on,   736 

distinguished    from    notes,    147 

estimating     market     for,      142, 
144 

income,   interest  on,    685 

issued   to   finance   construction, 
736 

long-term    and   short-term,    145 

participating,  141 

profit-sharing,    141 

redeemable,    145 

regulating  income  on,  141 

sinking  fund  vs.  serial,   150 

U.      S.,      bank      notes      issued 
against,   638 

U.   S.,   held  bv  national  banks, 
638 

999-year,    145 
Book  accounts,   539 

basis  for   loans,  619 

compared    with    trade    accept- 
ance, 649 
Bookkeeping,    double-entry,    687 

equation,    696 


798 


INDEX 


Bookkeeping,     double-entry,     prin- 
ciples, 687 

single-entry,   698 
Books   of   account,   columnarization 

of,  695 
Books,  closing,  690 

opening,  696 

of  original   entry,  693 
Borrower,   limitations  upon,  In   re- 
discounts,  646 
Borrowing  funds,  134 

when  to  borrow,  134 

from    investors,    136 
Borrowing,  methods  of,  586 
Bradstreet's,    562 
Branch   stores,  464 
Branded    products,    in    mail-order 

selling,  473 
Brandeis,  L.  D,  284,  334 
Bricklaying,    improvements    in,    327 
British    trade,    extent    of,    680 
Brookmire    statistical    organization, 

583 
Biicher,    Evolution    of   Industry,    10 
Buildings,  demolition  of,  725 
Buildings,   valuation  of,  725 
Bureaus  of  credit  Information,   565 
Burr,  Aaron,   Bank   of   Manhattan, 

Business  conditions,  charts,  576,  577 

cycles  of,  155,  573 

forecasting,  572,  579 
Business,  defined,  8 
Business,   the   science  of,    i   et   seq. 
Business    and    political    science,    54 
Business  problems,  nature  of,  21 
Business  training,   scope  of,  5 
Business   statistics,   Copeland's,    582 
Business    transactions,    analysis   of, 

687 
Buyers,  classes  of,  434 

how   reached,   511 
Buying  labor  by  specifications,  288 
Buying   by    specifications,    389 
By-products,  in  cost  accounting,  767 


Cables,     in     foreign     exchange, 
667 
sold   against   demand,   677 


Cable  rates,  668 
Call    loans,   617 

influence  on  money  movements, 
618 
Call    money,    rates   of   interest   on, 

617 
Capital   account,   736 
Capital,  defined,  loo,  718 
for    extension,    132 
sources  of,  134 
when  to  borrow,   134 
working,    127 
Capital    expenditures,    Government 

regulation  of,  536 
Capital    expenses,    calculation    of, 

123 
Capital    funds,    defined,    130 
Capital  Issues  Committee,  536 
Capital    items,    incorrectly   charged 

as  expense,  685 
Capital    liabilities,   737 
Capital  ratings,  by  credit  agencies, 

562 
Capital  and  revenue,  differentiated, 

699 
Capital    and    surplus,    738 
Capitalization  of  expenditures,  701 
Capitalization,    factor    in    carriers' 

rates,   494 
Capitalization  of  prepaid  expenses, 

735     . 
Capitalized  charges,  in  accounting, 

723  . 

Card  index,  264 

Carriers,  competition  of,  493 

Carriers'    rates,   basis   of,   485 

on  different  commodities,  495 

Carriers'   service,   cost   of,   49 

Cartage,  734 

Cash   account,    in   bookkeeping,   688 

Cash  in  banks,  defined,  730 

Cash  in  banks,  in  forecasting  busi- 
ness conditions,  580 

Cash    books,    694 

Cash  discounts,  in  cost  accounting, 
760 

on  sales  and  purchases,  750 

Cash    discounts    and    trade    accept- 
ances, 649 

Cash     resources,     increase     of,     by 
Federal  Reserve  banks,  637 


INDEX 


799 


Cash    sales,    on    income    statement, 

744 
Cashier's  checks,  544 
Catalogue  houses,  473 
Catalogue    sizes,    standard,    265 
Causality,    law    of    in    forecasting, 

579 
Centralized   control,    189,   419 
Central   filing  system,   260 
Central    reserve   cities,    637 
Certificate,  hypothecation,  665 

voting  trust,   116 
Certificates  of  indebtedness,  648 

of  origin,   518 
Certified   checks,    544 
Chain    Store    Grocers'    Association 

of  New  York  Cit}',  471 
Chain  stores,  467 

opposition  to,  472 
Chamber  of  Commerce,   U.   S.,   651 
Channels  of  distribution,   461 
Character,    element    of    borrowing 

power,   589 
Character,  in  salesmanship,  443 
Charge  accounts,  558 
Charges    against    income,    750,    762 
Chattel     mortgages,      in     financial 

statements,  737 
Checking    accounts,    613 
Checks,   539 

cashier's,  544 

certified,  544 

clearing  of,  625 

defined,   543 

in   foreign   exchange,   667 

fraudulent,  543 
Chemistry,  aid  to  business,  18 
Cherington,   Paul    T.,    87 
Church,  A.  H.,  94 
Circular  letter  of  credit,  specimen, 

.548 
Circulation,    of    money    and   credit, 

602 
Circulation    privilege,    638 
Civil   law,  defined,   58 
Classes  of  banks,   603 
Classical      school      of     economists, 

50 
Classification,    carriers'    rates,    496 

of  employees,   311 
Classification,  rules  for,  102 


Clayton   Act,   labor   exempt   under, 

289 
Clean  bill  of  exchange,  517,  664 
Clearing  house,  defined,  624 
Clearings  and  collections,  differen- 
tiated,  625 
Climate,    factor    in    selling    plans, 

434. 
"Closing  the   books,"  690 
Cole,  William  Morse,  760 
Collateral    bonds,    542 
Collateral,     for     Federal     Reserve 

notes,  640 
Collateral   loans,   620 
Collateral     on     loans    of    Reserve 

banks  to  Member  banks,  642 
Collateral  trust  bonds,  752 
Collateral    trust    notes,    148 

specimen,    621 
Collections,    566;    factor   in    selling 

cost,  418 
Collective  bargaining,  279,  283,  314 
Columnarization    of    books    of    ac- 
count, 695 
Combinations,  419 
industrial,    no 
Commercial  banks,  613 
purpose  of,  615 
security  holdings  of,  617 
Commercial    drafts,    544,    545,    663 
Commercial    letters    of    credit,    539 
Commercial     loans,    basis    of,     615 

purpose  of,  604 
Commercial    paper,    collateral    for 
reserve  notes,  640 

discount,    rediscount    and    pur- 
chase of,  642 
Commercial   paper,  in  Federal  Re- 
serve system,  642  et  seq. 

issue  of  reserve  notes  against, 
634 
Commission  merchants,  463 
Committee     management,     t>pe     of 

organization,  198 
Commodity'   paper,    645 
eligibility  of,   651 
special   rate  on,  652 
Commodity    prices,    index    number 

of,   578 
Commodity'   rates,   497 
Common  law  and  statute  law,   59 


8oo 


INDEX 


Common-law  trust,  105 
Common    stock,    114 
Commons,  John   R.,   278 
Comparative    balance     sheets,     741 
Comparisons,     in    cost     accounting. 

Competing  articles,  analysis  of,  436 
Competition       among       mail-order 
houses,   475 

effect   of,    120 

factor  in  selling  cost,  418 
Competition   system   and   enterpris- 
ers' profits,  572 
Competitors,   products  of,  435 
Composite   barometers,    583 
Compositions  with  creditors,  176 

in   bankruptcy,    568 
Confidence,   factors  in,  442;   chart, 

444 

Confidence,  relation  of,  to  credit, 
589 

Conlin,    Income    Tax    Reports,    100 

Consignment  shipments  in  account- 
ing,  703 

Consignments,  not  completed  sales, 

744 
Consolidated      income      statements, 

752 

Consolidation,  116;  through  stock- 
holding,   117 

promoter's  problems  of,  126 

Construction  charges,  in  cost  ac- 
counting, 725,  781 

Consumer   pays,   413 

Consumer,   selling  direct  to,   461 

Continuity  of  service,  wage  factor, 

303 
Contracted  goods,  valuation  of,  735 
Contracts,  law  of,  59 

valuation  of,  in  accounting,  703 
valuation  of,  leasehold,  723 
Control   of  business  enterprise,  242 
Control,  centralized,  189 
of  industry,  320 
of  labor   (chapter),  320 
Controlled  corporations,    117 
Controlled     organizations,     invest- 
ments  in,   733 
Controlling  accounts,  696 
Convenience,  sales  appeal,  430 
Conventions,  of  salesmen,  457 


Conversion  of  U.  S.  bonds,  638 

Convertible  credit,  634 

Co-operation    of    dealers,   472 

Copeland,   M.    H.,   Business  Statis- 
tics,   16,    17,    77 

Copyrights,  728 

Corn  Exchange  Bank,  statement  of, 
720 

Corporate   mortgage,    137 

Corporation,    105,    in 

accountability  of,  to  stockhold- 
er,  543 
investment   advantages  of,    542 

"Corrected    clearings    index,"    579 

Cost  accounting   (chapter),  754 

Cost  forms,  793 

"Cost  of  goods  sold"   account,  788 

Cost-of-living     wage      adjustment, 

318 
Cost  records,  765,  784,  793 
Cost  of  sales,  how  ascertained,  745 
Cost    systems,    756 

general  benefits  of,  756 
Cost  units,  772 

Costs,  selling,  classification  of,  416 
Court    of    Industrial    Relations    of 

Kansas,  281 
"Cover"     paper,     in     foreign     ex- 
change, 679 
Country  banks,  defined,  637 
Credit    (chapter),   533 

classes  of,   553 

conservation  of,  600 

defined,  533,  587 

demands     for     conversion     of, 

.597 

distribution  of,   598 

economic  considerations  in  ex- 
tension of,  549 

effective   and   potential,   589 

forms   of,    538 

line  of,  622 

liquidation  of,  597 

nature  and  origin  of,  587 

needs  for  different  classes  of, 
603 

in  panics,  575 

public  and  private,  585 

redemption    of,    594 

substitute    for   money,    538 

terms  of  mercantile,  554 


INDEX 


8oi 


Credit,   total    available    supply   of, 
588 

typical  instruments  of,  533 
Credit  agencies,  562 
Credit   applicant,   sources  of  infor- 
mation concerning,   562 
Credit  currency,  634 
Credit  department,  214 
Credit  extension,  basis  of,  561 

cost  of,   597 

economic  considerations  in,  534 

ethics  of,  535 

Federal   Reserve   Board  super- 
vision   of,    536 

governmental     supervision     of, 

534,    546 

Credit  as  medium  of  exchange,  598 

Credit  of  general  acceptability,  538 

Credit  guaranty,  569 

Credit  information,  562 

Credit   insurance,    569 

Credit  of  limited  acceptability,  539 

Credit  man,   565,   570 

Credit   Men's   Association,   Nation- 
al, 565 

Credit  and  prices,  601 

Credit  ratings,  534,  560 

Credit  risk,  538 

Credit  safeguards,  569 

Credit  sales,   on   income  statement, 
744 

Credit  stage  of  business,  8 

Credit    system,    soundness    of,    590 

Creditors'   accounts,    697 

Credits,  dollar,  655 

Criminal  law,  defined,  58 

Crops,  financing  movement  of,  652 

Cumulative   preferred   stock,    114 

Cumulative    value    of    advertising, 
423 

Currency,  credit,  634 

Currency,   elasticity  of,  633 
irredeemable,  680 

Current  assets,  704,   730 

Current    assets    and    liabilities,    ra- 
tio between,  737,  739 

Customers'    accounts,   697 

Customers,     analysis     of     possible, 

433 
Customers,  credit  classifications  of, 
566 


D 


Day    book,    693 

Day-book   journal,    693 

Dealers'    profits,    factor    in    selling 

price,  432 
Debenture  bonds,   137,   542 

notes,  147 
Debits  and  credits,  in  bookkeeping, 

687 
Debtor,  In  bankruptcy  proceedings, 

568 
Debtor's    property,    disposition    of, 

176 
"Declining      balance      unscientific" 

method,  depreciation,  calculation, 

709 
Deductive    reasoning,    85 
Defective    goods,    claims    and    al- 
lowances  for,   733,   745 
Deferred   charges   to   expense,   702, 

735 
Deferred  credits  to  income,  738 
Deferred   maintenance,    159 
Deficiency'    of    reserves,    tax    upon, 

642 
Definition,  method  of,  96 
Delivery,  schedules  of,  383 
Delivery  systems,  consolidation  of, 

479,  481 
Demand,   analysis  of,   421 

ascertained    from    sales   quota, 

454 
Demand  loans,  617 
Demand  paper  ineligible,  643 
Democracy  in  business,  45 
Demurrage,  500 

Departmental   organization,   196 
Departments,   basic,   208 
Depleted    reserves,    restoration    of, 

642 
Depletion,   defined,   711 
Depletion  reserve,  724 
Depositor,    line    of    credit    entitled 

to,   622 
Deposits,    593,    636,    637 
Depreciation,   779 

on   buildings,   722 
defined,  704 

on       removable      fixtures      or 
leased   ground,    723 


5o2 


INDEX 


Depreciation  account,  705 
Depreciation  calculations,  706,   707 
"declining     balance     scientific" 

method,   710 
'declining      balance      uuscien- 

tific"  method,  709 
"fixed-percentage"  method,  708 
"production-unit"    method,    710 
"straight-line"   method,   709 
"weighted-year"    method,    709 
Depreciation    charge,    varied    with 

current  surplus,   710 
Depreciation  "fund,"  713 
Depreciation,  periods  of,   16,   573 
Depreciation  and  repairs,  705 
Depreciation      reserves,      improper 

•creation  of,  685 
Depreciation,    spread   over   life    of 

asset,    708 
Derrick,  Paul  E.,  413,  478 
Desks,  253 
Development    of    foreign    markets, 

510 
Dewey  Decimal  system,  263 
Dewing     "Corporate     Promotions," 

163 
Diesel  engines,  521 
Differential  rates  in  transportation, 

493 
Direct  labor,  758,  761 
Direct  labor  cost,   773 
Direct  labor  hours,  773,  775 
Direct  labor,  in  valuation  of  goods, 

734 
Direct  lighting,  250 
Direct  materials,  758 
"Direct  to  consumer,"  461 
Disciplinarian,  206 
Discipline,  of  union  employees,  315 
Discount  on  bills  of  exchange,  665 
Discount,  defined,  616,  643 
Discount,    rediscount   and   purchase 

of  commercial  paper,  642 
Discount  on  bonds,  736 
Discounts,  cash,  555 
Discrimination,    in   carriers'    rates, 

494 
Distributable    overhead,    764 
Distribution  of  authority,  chart,  191 
Distribution  of  business  income,   15 
Distribution  of  business  profits,  189 


Distribution,  channels  of,  chart,  462 
Distribution  costs,  reduction  of,  481 
Distribution,   factor  in  selling  cost, 

418 
Distribution  of  net  profit,  751 
Distribution     of     overhead,     chart. 

Distribution,  retail,  479 
Districts,  Federal  Reserve,  632 
Dividend   equalization   reserve,   165 
Dividends,    authority    for    payment 
of,    164 

expediency  in  payment  of,   162 

Federal  Reserve  Bank,  633 

law  of,   162 

paid  out  of  surplus  or  capital, 
163,    164 

postponed,  167 

scrip,   stock    and    property,    167 

on  treasury  stock,   729 

from   wasting   assets,   724 
Dividends  from  capital,  prohibited, 

738. 

Division  of  labor,  in  line  organ- 
ization,   193 

Dock  receipts,  518 

Documentary  bill,  516 

Documentary  drafts,  547 

Documentation,    515 

Dollar    credits,    680 

Dollar  exchange,  acceptances 
drawn  to  furnish,  645 

Domestic  bills  of  exchange,  653 

Domestic  letter  of  credit,  specimen, 

549 
Donated   stock,    161,   729 
Donated  surplus,   163 
Donation   reserve,  730 
Door  delivery,  480 
Double-entry  bookkeeping,  687 
Double-name    paper,    620 
Drafts,  539  et  seq. 
Duncan,    Robert   Kennedy,    19 
Dun's  Commercial   Agency,    562 
Du  Pont  Powder  Company,  422 
Duplication    of    delivery    systems, 


Earning  assets,  of  Federal  Reserve 
banks,    637 


INDEX 


803 


Earnings    reinvested,    738 

Earnings,    employees',    under    pre- 
mium wage  systems,  300 

Eastman     Kodak     Co.,     suggestion 
system,  200 

Econom?ts,  29  et  seq. 

Economic  science,  history  of,  50 

Efficiency  experts,  61,  207 

Efficiency  wages,  289 

Eight-hour   day,   283,   331 

Elasticity  of  the  currency,  633,  639 

Elemental  unit  times,  231,  302 

Elements  of  cost,   757    (chart),   758 

Eligible  paper,  638 

collateral     for     reserve     notes, 
640 

Eligibilin\    of    commercial    paper, 
647,  658 

Embargo  on  gold  exports,  632,  672 

Emerson   efficiency   wage,   297,   306 

Emmet,    Boris,    314,    317 

Employees,   selection   of,   238,    338 
securing    co-operation    of,    341 

Employees'      benefit      associations, 
management  of,  356 

Employers'  associations,  278 

Employer's  housing,  366 

Employment,   continuity   of,   344 

Employment   department,    339 

Endorser,    contingent    liability    of, 

73.1 
Engineering  Magazine,  701 
Entrepreneur,   profits  of,   15 
Enterpriser,  defined,  184 
Enterprises,      forms      of     business 

(chapter),  104 
Environment  of  business,  4 

(chapter),   12 
Environment   of   consumers,    factor 

in  selling  plans,  434 
Equation,  bookkeeping,  687 
Equation,  wage,  303 
Equipment    account,    725 
Erickson,  Elmer  E.,  on  rush  orders, 

393 
Escher,  Franklin,  668,  677,  678 
Ethics,  34 

Ethics  of  business,  7 
Evening  Sun,  New  York,  444 
Evolution  of  management,  218 
Exact   sciences,   24 


Exchange   (chapter),  660 
Exchange,  classes  of  dealers  in,  676 
factors  in  rates  of,  670 
on   foreign  countries,   673 
on    New    York,    662 
process   of,   661 
rates  of,  669 
speculations  in,  676,  678 
system   of,   661 

transactions    involving   use    of, 
660 
Exclusive  agencies,  463 
Expansion,  capital  for,  132 

allowances  for,   in  plant  loca- 
tion,   188 
Expansion  of  currency,  633 
"Expected    loss,"    in    credit    insur- 
ance, 569 
Expense,    deferred   charge   to,   702, 

735 
Expense     proportion,     in    cost     ac- 
counting,  774 
Expenses  accrued,  defined,  737 
Expenses,     distinguished    from     in- 
vestments, 700 

general      and      administrative, 

7+9. 
prepaid,  in   accounting,  735 
Experimentation  in  business,  76 
Experts,    61 

Experts,    aid    to    management,    221 
Exports,      nature      of,       effect      of 

changed  conditions  on,  506 
Express  traffic,   500 
Extension  of  credit,  defined,  587 


Factory  cost,  761 

Factory  location,   366 

Factory  overhead,  758,  795 

Facts,  how  collected,   63 

Failures,    business,    170 

Fair     distribution    of     profits,     189 

Fair  wage,  240,  274 

False  statements,  in  prospectus,  155 

Farm  Loan  Act,  provisions  of,  6i3 

Farm  loan  associations,  611 

Fatigue,    327,    330 

Federal  Farm  Loan  Act,  6ii 


8o4 


INDEX 


Federal   Income   and   Excess   Prof- 
its taxes,  nature  of,  751 
Federal   land  banks,  611 
Federal     Reserve     Act,    note    issue 

under,  639 
Federal  Reserve  banks,  deposits  of, 
636;  capitalization  of,  632 

earnings  of,   633 

gold  coin  and  bullion  dealings 
of,   656 

open-market    dealings    of,    657 

Treasury  funds  in,  636 
Federal    Reserve    bank    notes,    636 

replacing      silver      certificates, 
638 
Federal     Reserve     Board,     general 
policy  of,  647 

may    require    banks    to    redis- 
count  for   each  other,   636 

organization  of,  632 

rates  fixed  by,  642 

suspension   of   reserve   require- 
ments  by,    641 

"ioo9'r  permit"  granted  by,  654 
Federal  Reserve  City,  637 
Federal   Reserve   notes,   638 

application   for,   640 

authorization  for  issue,  639 

gold   security   for,   635 

issued   against  commercial   pa- 
per,   634 

issued  against  gold,  635 

redeemable  in  gold,  641 

redemption  of,  634 

reserves   held  against,   636 

volume    of,    638 
Federal  Reserve  system,  631 

objects  of,   633 

operation   of,    636 

organization    of,    632 
Federal  Trade  Commission,  756 
Fifteen-day     loans,     reserve    banks 

to  member  banks,  642 
Filing,   259 

classification    before,   261 

systems,  262 
Finance    bills,    667 

defined,  679 
Financial    advertising,   156 
Financial   department,  208 
Financial  risk,  defined,  143 


Financial  statements  (chapter),  714 
in  credit  extensions,  556 
laws  requiring,  715 
protection       against      bad-debt 

losses,    715 
required    of   corporations,    list- 
ing   securities    on    stock    ex- 
change,   715 
Financing   (chapters),  119,  159,  170 
chart,     distribution     of     funds, 

119 
defined,  6 

through   bond   issues,    136 
Findings    account,    759 
Finished    goods,    valuation    of,    734 
Fiscal    period,   in    bookkeeping,   690 
Fixed  assets,  defined,   722 
in  accounting,  704 
in  balance  sheet,  719 
Fixed    charges,    in    wage    equation, 

304 
Fixed    investments,     paper    drawn 

for   ineligible,   644 
Fixed   liabilities,   737 
Fixed   machine-rate,    773,   776 
Fixed-percentage     method,     in     de- 
preciation  calculations,    708 
Fixed  and  variable  costs,  509 
Fixtures  installed  by  tenant,  723 
Flagg,  Sir  Stanley  G.,  Jr.,  on  pack- 
ing- 514 
Fleisher,     Alexander,    on    mainte- 
nance  work,    354,    371 
Floor   space,  office,   248 
Follow-up  letters.  476 
Ford  wage  system,  297,  306 
Forecasting       business      conditions 
(chapter),   572 
basis  of  intelligent,   579 
bibliography,    583 
possibility  of  accurate,  578 
Foreclosure  sale  of  corporation  as- 
sets,  181 
Foreign     banking     and     American 

banks,    531 
Foreign   exchange,   transactions   in, 

Foreign    letter    of  credit,    specimen, 

550 
Foreign    markets,    development    of, 

510 


INDEX 


805 


Foreign  trade    (chapter),    504 
Foreign    trade,    credit    information, 

economic  justification  of,  508 

financing,    530 

future    trend,    505 

present  trend,    505 
Foreman,    in    departmental    organ- 
ization,   196 

in  functional  organization,  202 

in   line  organization,   194 

in  suggestion  system,  200 
Form  letters,  standards,  249 
Forms      of      business      enterprises 

(chapter),    104 
Forms,   standardized   report,   258 
Formula,   wage,    303 
Franc,  674 

France,  par  of  exchange  on,  669 
Franchises,  defined,  728 
Franklin    Motors    Company,    wage 
SNStems  of,  302 

employment     order     in     shops, 

341 
Freight  bill,   500 
Freight  charges,   basis   of,  484 
Freight,   classification   of,   495 
Freight,    highway,    480 
Freight  rates,  ocean,  523 
Freud,  Sigmund,  474 
Functional  departmentalization,  208 
Functional   foremen,   203,   206 

number  of,  211 
Functional    organization,    201,    207 
Fundamental     business     conditions, 

575 
Fundamental    wage    base-rate,    303 
Funds,    chart   showing   relation    of, 
119 
borrowing,   134 
for  reorganization,   179 
forcing  from   stockholders,    179 
investment      and     commercial, 
607 
Funds    and    reserves    for    deprecia- 
tion, 711 

G 

Gain-sharing,  298,  360 
Gang  boss,  in  departmental  organ- 
ization,  197 


Gang  boss,  in  functional  organiza- 
tion,  205 
Gantt,  H.  L.,  on  securing  efficiency, 

76 ;  wage  system,  297,  305 
Gary,    Elbert    H.,    on    adoption    of 

eight-hour   day,   337 
General  accounting,  754 
General     and     administrative     ex- 
penses,   749 
General    balance    sheet,    specimen, 

719 
General  franchises,  728 
General    ledger   accounts,   788 
General    Motors    Corporation,    em- 
ployees' stock-owning  bonus  plan, 
364 
General  overhead,  758,  793 
Genus    and    species,    96 
German  Historical  School  of  Econ- 
omists,   52 
Giddings,    "Lecture    on    SocioIog^■," 
38        .     . 

"Principles    of    Sociology,"    40 
Gilbreth,    F.   B.,    327 
Gilson,   Mary  B.,    350 
Glycogen,       in       fatigue       studies, 

327 
Going-concern    value,    99,    127 
Gold,   accumulation  of,  by  Federal 
Reserve   banks,    640 
the  basic  money,  641 
coin    and   bullion,    dealings    in, 

by  reserve  banks,  656 
cost   of   shipment   and   rates  of 

exchange,    670 
disappearance      from     circula- 
tion, 641 
movements      in      foreign      ex- 
change,   675 
reserve    notes    issued    against, 
640 
Gold  points,   670,   675 
Gold  redemption  fund,  637 
Gold-standard   countries,    680 
Goods,  valuation  of,  734;   in  proc- 
ess  of   manufacture,    740 
Good-will,    127 

in  accounting,  727 
defined,   99 
source  of,   433 
valuation   of,   727 


8o6 


INDEX 


Government  credit,    585 

Government  as   promoter   of   busi- 
ness,  57 

Government  and    social    activities, 

Governmental   control   of  business, 
420 

Gray,  John  H.,  81 

Greenbacks,    amount    of    outstand- 
ing, 639 

history  of,  639 

Grieves,   W.   A.,   on   shorter  work- 
day,   336 

Gross   income,   744 
estimating,    122 

Gross  profit  on   sales,   on  cost,  748 

Gross  sales,  744 

Group    insurance,    357 

Group  specialization,   in  organiza- 
tion,   196 

Guaranties,  credit,   569 

Guaranty   Trust   Company,   organ- 
ization chart,  605 


H 


Habit,  factor  in  observation,  67 

Habits  of  buying  public,  factor  in 
sales  plans,  435 

Hague  Rules  governing  foreign 
trade,  516 

Halsey  wage  system,  297 

Harriman,  E.  H.,  Control  of  North- 
ern Pacific,  64 

Harter  Act  of  1893,  516 

Hatfield,   H.   R.,   706 

Haul,  length  of,  as  factor  in  rates, 

494 

Hearings,    on    Taylor    system,    301 

Heat,  item  of,  in  cost  accounting, 
780 

Hepburn  Act,  501 

High   cost   of   selling,   414 

High-speed  steel,  230 

Highway  freight,  480 

Hill,  James  J.,  64 

Hiring  rate,  312 

Hirings,  avoidable  and  unavoid- 
able,   347,    350 

Hoarding,    672 

Hobson,  J.  A.,  24,  43 


Holding    Company,    118,    752 

Hollingsworth,    H.   L.,    77 

Hollingsworth  and  Poffenberger, 
66,  67 

Hollingsworth  and  PoflFenberger,  on 
fatigue,   329 

Housing,   282 

Human   element  in   business,  73 

Humidity,  in  office  ventilation,  252 

Hunger,    Edwin    A.,    200 

Hypotenuse  oblong,  265 

Hypothecation  certificate,  la  for- 
eign exchange,  665 

I 

/  Promessi  Sposi,  430 

Idle  cars,   in   business   barometrics, 

579. 
Idle  time,  757,  782 

charged  to  factory,  783 
charged    to    sales    department, 
783 
Ihlder,    John,    of    Phila.    Housing 

Com.,  370 
Illusion,  cause  of  mal-observation, 

^5  .       .       . 
Imagination  in  business,  30 
Imitations,  427 
Impartial   management,   243 
Imports    and    exports,    in    foreign 

exchange,   662 
Imports,    nature   of,    507 
Improvements    on    leased    property, 

723  . 
Incentive  wages,   277 
Income,    anticipation    of,    703 
charges    against,    750 
from     operations,     how     ascer- 
tained, 749 
management  of,  159 
when   earned,  703 
Income  bonds,   684 
Income  statement,  742 
Income   tax,    not   expense  of  doing 

business,  751 
Incorporated   banks,   626 
Indebtedness,     extinction     and     re- 
funding  of,    148 
Indirect   labor,   232,   761 
classes  of,  779 


INDEX 


807 


Indirect   lighting,   251 
Indirect  materials,  758,  781 
Industrial  banks,  604,  606 
Industrial   credit,   659 
Industrial    Management,    on    labor 

turnover,    349,    350 
Industrial    production    as    influence 

in  business  changes,  580 
Industrials,  capital  required  by,  128 
Industry,   control    of,    320 

distribution  of  products  of,  270 
socialization  of,  49 
Inferences,  81 

Inflation  of  inv'entories,    764 
"Influencing  men   in  business,"  450 
Infringements,  trade  name,  427 
Initial    loss,    569 
Initial  working  capital,  127 

estimating     requirements     for, 
129 
Insolvency,    bankruptcy    and    reor- 
ganization, 170    . 
Insolvency,   remedies  for,   172 
Inspection  of  purchases,  398 

at  the  source,  399 
Inspector,    in    functional    organiza- 
tion, 205 
Installment   purchases,    in    account- 
ing,   726 
Instruction-card  man,   204 
Insurance,   credit,    569 
Insurance,  express  and  parcel  post, 

502 
Insurance,    in   cost    accounting,    780 
Intangible   assets,   727 
Interbusiness    standardization,    233, 

419 
Intercompany  profits,  753 
Interest,    in    cost    accounting,    763, 

764.  782 
Interest  on   bank   loans,   595,   617 
Interest    rates,    stabilized    by    Fed- 

-eral    Reserve   system,    637 
International   Harvester  Co.,   510 
Interstate    Commerce    Act,  494 
Interstate    Commerce    Commission, 

loi,  70S 
Intuition,  30,  575 
Inventories,  classification  of,  733 
inflation  of,  764 
perpetual,  768 


Inventory,   average,  749 
Inventory,    in   bookkeeping,    691 

checking   for    accurac\',    749 

increase    and   decrease    in,    746 

purpose  of,  698 
Invested  capital,  100 
Investment  banks,  604 

marketing  of  securities  by,  607 
Investment  credit,    553 
Investment    funds,     where     obtain- 
able, 553 
Investment  paper  ineligible  for  re- 
discount, 644 
Investments,    foreign,    678 
Invoice,  516 

in  foreign  trade,  518 
Invoice,   terms   of,    555 
Invoices,  entered  "net,"  760 
Inward  charges,  760 
Iron  Age,  2 

Irredeemable    currency,    680 
Italy,  par  of  exchange  on,  669 


J 


James,  Psychology,  66,  67,  79 

Jevons,  Logic,   73 

Jevons,  W.  I.,   2 

Jobber,  461,  472 

Johnson,   Joseph    French,    35 

Joint-stock  company,   105,   109 

Joint-stock   land  banks,   611 

Jones  Act  of  1920,   524 

Jones,  E.  D.,  "2,  90 

Jones,  "Logic,  inductive  and  de- 
ductive,"  13,   64,   66,   70,   96 

Journal,    in    bookkeeping,    693 

Journal   of  Political  Economy,   135 

Judgment,  supplementing  standard- 
ization, 216 


K 


Kemble,  "Choosing  Employees,"  83 
Keysen,  C.  J.,  Columbia  University 

Lectures,    12 
King,  Elements  of  Statistical  Meth- 
od,  14 
"Knocking"  competitors'  goods,  436 
Krone,   Mint,  valuation  of,   669 


8o8 


INDEX 


Labor,  adjustment  account,  772 
Labor,  commodity  view  of,  289 
Labor  cost,   defined,  325 

estimates  of,  302 

reduction  of,  318,  326 
Labor,   direct   and   indirect,   232 

direct  and  indirect,  in  account- 
ing, 747 

elements  paid  for,  287 

in   plant   location,    187 

protected  by  public  opinion,  324 

records,  771 

share  in  profits,   189 
Labor    legislation,    280 
Labor  turnover,  losses  due  to,  354; 
calculation    of,     345;     "refined," 
347;   means   of  reducing,   353 
Labor     unions,     policies     of,     279; 
membership   of,   280 

opposition    to    piece-rates,    316 

time-study,  engineer  of,  309 
Lading,   bill   of,   498 
Land  banks,  611 

Land,  charges  against,  in   account- 
ing, 722 

profits  due  to  ownership  of,  762 

valuation  of,  722 
Large-scale  production,  relation  of, 

to  selling  costs,  417 
Law  and  business,  58 
Law,  civil  and  criminal,  58 
Law    and    equity,    59 
Law,  substantive  and  adjective,  58 
Lay-out,  office,  248 
Leadership  in  management,  241 
Leads,    in    salesmanship,    453 
Leased    ground,    improvements   on, 

723 
Leasehold   rights,   723 
Ledger,  plant,  779 

posting  from  day  book,  693 
Leffingwell,  W.   H.,  261 
Legal      investments      for      savings 
funds,    610 

restrictions,    in    plant    location, 

Legislative  management,  198 
Leifer    Magnusson,    on     industrial 
housing,  366 


Lending   deposits,    595 
Letters  of  credit,  667 

classes  of,  667 

commercial,   539,  546,  667 

specimen,  548,  549,  550 

travellers',    539,    667 
Letters,  test,  69 
Liabilities,    analysis  of,   736 

in  bookkeeping  equation,  687 

and  capital,  736 

current,  737 

fixed,  737 
Liability    account,    in    bookkeeping, 

688 
Libraries,  business,  264 
Light,     units    of    measurement,    in 

cost    accounting,    780 
Lighting,  office,  250 
Limited  partnerships,   108 
Limits  of  wages,  272 
Line  of  credit,  622 
Line  organization,  192;  advantages 

and    disadvantages    of,    195 
Line-and-staff    organization,    195 
Living,    cost    of,    as    wage    factor, 

393 
Living  wage,  283 
Live-stock  paper,  645 
Load-factor,   defined,   207 
Load-factor     of     business,     adjust- 
ment of,  571 
"Loanable    funds"    and    trade    ac- 
ceptances, 557 
"Loanable  funds,"  relation  to  cred- 
it, 588 
Loan  associations,  agricultural,  611 
Loan-value    of    assets,    calculation 

of,    592 
Loans,  classes  of,  616 
defined,  642 
foreign,    678 

interest  paid  by  depositors,  595 
long-term   and   short-term,  dif- 
ferentiated,  603 
purposes  of  various  classes  of, 

604 
real    estate,    630 
of    reserve    banks    to    member 

banks,  642 
seasonal,   603 
Loans  and  discounts,  defined,  616 


INDEX 


809 


Loans  and  discounts  in  relation  to 
reserves,   636 

Location    of   plant,    184;    of   chain 
stores,  470 

Logic,  12 

London,  exchange  on,  670,  673 
exchange    facilities   of,    680 

Long-term    credit,    for    agricultural 
purposes,  611 

affected     by    Federal     Reserve 
system,    659 

"Loss-sharing,"  360 

Losses,     unusual,     how     shown     in 
financial   statements,  751 

Lost  motion,  elimination  of,  206 

Lotze,  Logic,  70 

Lough,    W.    H.,    "Panics    and    De- 
pressions,"   580 

Luxuries,  demand  for,  432 

Lyon,    Hastings,    137 

M 

Machine-hour    summary,    791 
Machinery   account,  706,  725 
in  balance  sheet,  739 
substituted  for  labor,  326 
Made-in-Germany  trade-mark,   531 
Mail,  handling  of,  256 
Mailing,  economy  in,  257 
Mail-order  competition,  478 
Mail-order    departments    of    retail 

stores,  477 
Mail-order    houses,   473 
Mail-order    sales    methods,    475 
Maintenance,  present  and  deferred, 

159 
Maintenance    work,    46,    344,    354, 

371 
Maladjustment  of  effort  in  produc- 
tion, 417 
Mal-observation,    causes   of,    65 
Malthus,  doctrines  of,  50 

influence    on    Darwin,    84 
Management     (chapter),    183;    de- 
fined,   183;    unity    of    control    in, 
188 

evolution  of   (chapter),  218 
expert  staff  aids  to,  221 
impartial,   243 
legislative,   199 


Management,   office    (chapter),  247 
primitive,   218 
record-keeping,  219 
s'^'entific,   224 
systematized,    220 
Management  of  income,  159 
Managerial    authority,    distribution 

of,  190 
Manhattan    Company   Charter,    67 
Mann-Elkins    Act,    501 
Manufacturers'     retail    stores,    465 
Manufacturing  cost,  allowance  for, 

748 
Manufacturing    costs,    how     ascer- 
tained, 746 

expenses,  750,  762 
Manufacturing   overhead,    761 
Manzoni,   /   Promessi   Sposi,  430 
Map  of  sales  districts,  452 
Map,  on  scale  of  population  or  of 

prospective   sales,   212 
Marginal    income,    expenditure    of, 

29 

Margins    of    business    profits,    765 

Marine   insurance,    517 
certificate,    516 

Maritime  Law  Committee,   516 

Mark,  Mint  valuation  of,  669 

Market,  analysis  of,  421,  433,  452 

Market     and     product,     correlation 
of,  421 

Marketing   conditions,    special,    510 

Marketing,   defined,    6 

expenses,     in     financial     state- 
ments,   749 

Markets,    practical    economy  of,   27 

Market    value,    basis    of    valuation 
of  assets,  704 

Marshall,    "Principles   of   Econom- 
ics," 31 

Marx,    Karl,    on    incomes,    52 

Massachusetts  Trust,    105 

Material,  charged  directly  to  prod- 
uct, 759 

Material     and    labor,    in    financial 
statements,   747 

Material  received  slip,  398 

Material    records,   765 
requisition,    766 

Materials,   direct   and   indirect,   758 

"Materials  purchased,"  cost  of,  759 


8io 


INDEX 


Mithematics,  in  science  of  business, 

13 
Maturity  of  sight  draft,  664 
Mediums  for  reaching  foreign  mar- 
kets,   512 
Member  banks  of  Federal  Reserve 
system,  subscriptions  of,  632,  635 
Member  banks'  loans  from  reserve 

banks,    collateral    for,    642 
Member   banks,    reserves  of,    636 
Memory,  in  collecting  information, 

79 

Mental  fatigue,  329 

Mercantile    credit,    553 

Merchandise   account,   in  bookkeep- 
ing equation,  688 
specimen,    691 
subdivisions  of,  692 

Merchandise,  cost  of,  defined,  734 
true   cost   of,    760 
valuation    of,    733 

Merchant,   as   distributor,  461 

Merchant  Marine,  Act  of  1920,  524 

Merchants'    associations,    533 

Merger,    defined,    117 

Methods  evolved  by  workmen,  221 

Micro-motion  study,  228 

Middleman,  432,   462 

economic  services  of,  460 

Mineral  deposits,  depletion  of,  724 

Mines,  depletion  of,  724 

Minimum   wage  commission,   284 

Minimum     wage,     guaranteed,     in 
cost   accounting,    772 

Minimum  wage   legislation,  283 

Minnesota     minimum     wage     case, 
285 

Mixed   accounts,   691 

Mnemonic  symbols,    769 

Mobility   of    reserves,    633 

Mobilization  of  banking  resources, 
627 

Model  towns,  367 

Moisture,  in  ottice  ventilation,  252 

Monetary  standards  in  foreign  ex- 
change,   680 

Monetary    system,    based    on    gold, 
602 

Monetary   units    of    different   coun- 
tries,   669 

Standardization   of,   68j 


Money  and  credit,  supply  adjus'cd 

to  business  needs,   633 
Money   orders,   546 

as    credit    instruments,     539 
Money-raising   and   money-making, 

157 

Money    stage    of    business,    9 

Money  substitutes,  must  be  re- 
deemable   in    specie,    602 

Money  wages  and  real  wages,  271 

Monopoly,    effect    of,     120 

Monopoly,  through  voting  trust, 
116 

Monotony,    explained,    310 

Montgomery,    R.    H.,    695 

Morgan,  J.  P.,  and  Company,  607 

Mortgage    bonds,    542  ' 

Mortgage  loans  under  Federal 
Farm   Loan  Act,   612 

Mortgages  securing  public  obliga- 
tions,   586 

Mortgages,  sinking-fund  provisions 
of,    712 

Mortgages,  corporate,  137;  equijy 
behind,  138;  security  behind, 
138;  closed-end,  open-end,  139; 
purchase    money,    139 

Mortgages,  how  shown  on  balance 
?hoet,    737 

Motive  power,  520 

Moulton,    H.    G.,    135 

Municipal  obligations,  eligible  for 
purchase    by    reserve    banks,    657 

MiJnsterberg,    Hugo,    77 

Mutual    savings   banks,    610 


N 


National      Association     of     Credit 
Men,   565,   651 

form    of    guaranty,    569 
National   Bank  Act,  628 
National   Banking  Act,  designation 

of    reserve   cities,    637 
National    banks,    625 
capital  of,  629 
disposal    of    U.   S.   bonds   held 

by,  638 
powers    of,    628 
National    Civic    Federation,   46 
Needs,   basis  of  selling,  411 


INDEX 


8ii 


Neglected    discounts    account,    760 
Negotiable      instruments      defined, 

539 
Net   income,    750 

Net    profit,    how    ascertained,    749 
Net    profits,    publication    of,   286 
Net   sales,    745 
Net  worth,   698 

New  York  bank  clearings,  in  busi- 
ness forecasting,  579 
New    York   exchange,    662,    663 
New    York    State     Department    of 

Education,    684 
Noise,  effects  on  office  workers,  253 
Nominal    accounts,    699 
Non-dumping  certificates,  518 
Non-participating    stock,    114 
Non-productive    loans,    600 
Norway,    par   of   exchange   on,    669 
Note   issue  of  banks,   595 
Note  issue  privilege,  638 
Notebrokers,    556 

Notes  of  company  officers,  in  finan- 
cial   statements,    731 
Notes    discounted    and    unpaid,    in 

accounting,  731 
Notes,   eligible,   defined,   645 
Notes,   Federal   Reserve,  638 

provisions   of   Act  authorizing, 
639 
Notes  payable,  classification  of,  737 
Notes,    promissory,    539,    540 
Notes  receivable,  in  accounting,  731 
Notes     representing     overdue     ac- 
counts,  732 
Notes,   short-term,    146 ;    debenture, 
147;  collateral  trust,  148 
unsecured,  643 


O 


Observation,    in    scientific    method, 

63 
Obsolescence,'  in    accounting,   706 
Occupations    and    rates    committee, 

311 
Occupations,      standardization      of, 

310 
Ocean  freight  rates,  523 
Ocean  traffic,  519 


Ocean    traffic    and     foreign    trade 

(chapter),    504 
Office,   defined,   247 

duties,    248 

equipment,   253 

functionalization    in,    266 

personnel,    selection    of,    254, 
Office    management    (chapter),    247 
Office   tasks,    assigning,   266 

classification    of,    256 

standardized,    268 
Old    machine-rate,    773,    776 
Omission,   error   of,    64 
On-cost    or    burden,    758 
"On    or    before"    paper,    eligibility 

of,  643 
Open    accounts,   732 
Open-market  operations  of  reserve 

banks,   643,   656 
Operating  expenses,    122,   749 
Operating  ratio,   123,  749 
Operations,    analysis    of,    228 
Order  bills,   516 
Order,  routing  of,  203 
Orders,  purchase,  393 
Ordinary    stock,    114 
Oregon  minimum-wage  law,  284 
Organization,     183      (chart),     209; 
accounting   systems    in,    687 

committee   or    legislative   man- 
agement,  198 

departmental,    196 

of    departments,    208 

expenses,    127 

expenses     in     financial      state- 
ments,  735 

form,    how    determined,    190 

forms   of,    104 

functional,    201 

line,    193 

line-and-staflF,    195 
Original    entry,    books   of,    693 
"Other  income,"  745,   750 
Overdrafts,  in  accounting,  730 
Overhead   distribution   of,   764,   773 
(chart),    778 

factory,   793 

general,    758,    793 

in  wage  equation,  303 
Over-production,    538 
Overtime,   why  profitable,  207 


8l2 


INDEX 


Overvaluation   of   assets,   730 
Ownership,   sharing,    363 


Package,    standardized,    429,    430 

Packing   list,    518 

Packing    problem,    513 

Panics,    574 

Paper,  commercial,  collateral  for 
reserve    notes,    640 

Paper,   commodity,   645 

Paper  eligible  for  rediscount  or 
purchase,    643 

Paper,   live   stock,   645 

single-name,    double-name,    ac- 
commodation, 620 

Par  of  exchange,  669 

Parcel   post,    502 

Parcel    receipts,   518 

Parent  company,  contingent  liabil- 
ity of,  738 

Paris,   rates  of  exchange  on,   674 

Partial-payment  plan,  purchase  on, 
in  accounting,  726 

Participating  preferred  stock,  114 

Partnership,    104 

advantages  and  disadvantages 

of,  108 
agreements,   107 

Partnerships,    general,    107 
limited,   108 

Patents,  in  accounting,  727 

Patterns,  drawing  and  dies,  valua- 
tion of,   726 

Paying  power,  basis  of  credit,   587 

Payment  bills,  665 

Paynter,  Richard  H.,  on  word 
trade-marks,  427 

Payroll,  how  made  up,  772 

Pearson,   Karl,   63,    84 

"Pegged"    rates   of   exchange,    670, 

Percentage  calculations,  in  income 
statement,   747 

Permanent  assets,   722 

Permanent  improvements,  rights  of 
landlord  and  tenant,  723 

"Permit"  for  making  increased  ac- 
ceptances,   654 

Perpetual   inventories,  768 


Personal  credit,   553,   557 

Persons,    Warren    M.,    on   business 

barometers,    573,    583 
Peseta,  Mint  valuation  of,  669 
Philadelphia's    purchasing    system, 

396 
Physical  capacity  of  workman,  328 
Physics   and   chemistry,   in   relation 

to  business,  17 
Piece-rates,  289,  292 
Piece-work    coupon,    771 
Place-value    of    commodities,    483 
Planning  department,  211,  231 

in  functional  organization,  206 
office,    248 
Plant   ledger,   779 
Plant,    location   of,    184;   chart,    185 
Point  contests,   salesmanship,  457 
Poise,  in  salesmanship,  448 
Police  power,  history  of,  55 

in  wage  legislation,  284 
Policies,  standardization  of  selling, 

.457        . 

Political   science   and  business,    54 

Population  theory  of  Malthus,   50 

Ports,  development  of,  509 

Post-dated  checks,  in  accounting, 
730 

Post-sales    service,   424 

"Posting"  in  ledger,  693 

Posting  of    accounts,   696 

Pound  sterling,  669 

Power,  charge  for,  in  cost  account- 
ing, 781  _ 

Pre-approach,  in  salesmanship,  443 

Preferential  rate,  for  trade  accept- 
ances,  648 

Preferred   stock,    114 

Prejudice,  cause  of  error  in  obser- 
vation, 64,  67 

Premium   wage-systems,    297 

Prentice-Hall,  Business  Forecast,  16 

Prepaid  charges,   in   sales   account, 

744. 
Prepaid   expenses,   735 
Present    maintenance,    159 
Present  worth,  defined,  738 
Price  corrections,   745 
Price  curve,    14 
Price-fixing,   factors  in  policies  of, 

33 


INDEX 


813 


Price    fluctuations,    explanation    of, 

431 

Taussig  on,  602 
Price    levels,    calculation    of,    15 
Price,  selling,  how  determined,  431 
Prices,    affected    by    credit    supply, 

601 
Prices,  in  business  barometrics,  574 

index    number    of,    578 
Prime    commercial    paper,    648 
Prime  cost,    773,   775 
Primitive   business,    10 
Principles  of  accounting   (chapter), 

684 
Priority  in  use  of  trade  names,  429 
Private  banks,  615 
Private   commercial    banks,    625 
Private  credit,   585 
Prizes  for  suggestions,  200 
Product,  charged  with  material,  759 
Product  and  market,  correlation  of, 

421 
Production,   "balance"  of,  535 
Production  centers,  757,  779 
Production  cost  in  relation  to  sell- 
ing price,   431 
Production,    credit    as    a    factor    in, 

534 
Production    department,     208,    210, 

chart  of,  211 
Production,      influenced      by      sales 

quotas,  454 
Production    order,    771  ;     specimen, 

784 
Production,  proportioned  to  selling 
facilities,  417  " 

relation  of  credit  to,  615 
Production-unit    method,    in    depre- 
ciation calculations,   710 
Productive  labor,  758 
Productivity,  factor  in  wages,  272 
Productivity     of     labor,     how     in- 
creased,   320-372 
Profit,    in    accounting,    691 
Profit  and  loss  account,  690 
Profit  and  loss  credits  and  charges, 

750 
Profit  and   risk,   243 
Profit,  selling,  749 
Profit-sharing,  defined,  357 
forms  of,   360 


Profit-sharing,   purposes   of,   358 

typical  plan  of,  361 
Profits,  calculation  of,   714 

conditions     favorable     for    the 
making  of,  433 

corporations',   751 

distribution    of,    189,   242,    751 

partnerships',    751 

securing,   11 

sole     trader's,     or     individual 
proprietor's,    751 

when  earned,  703 
Progressive     standardization,     235, 

237 
Promissory   notes,    539 

eligible  for  rediscount,  644,  645 

not    eligible    for     open-market 
purchase,  656 
Promoter,   calculations  of,    121 
Promotion,    120 

expenses    of,    123 
Promotion  of  employees,  342 
Prospectus  of  security  issues,  154 
Property   account,   722 
Proprietorship,       in       bookkeeping, 

687,   689 
Proprietorship,  individual,  104,  105 
Proration    of    inward    charges,    760 
Psycholog}-  of  advertising,  400;   of 

selling,  449,  469 
Psychology-  in  business,   26 
Psychology  of  panics,   575 
Public   credit,    585 

assets  supporting,  586 
Public  opinion,  force  of.  59 

factor     in     profit     distribution, 
189 

in  wage  controversies,  285,  586 
Public    utility   security    issues,    685 
Publicity,   cost   of  maintaining,  422 
Purchase  of  commercial  paper,  643 
Purchase  orders,  393 
Purchase  requirements,  analvsis  of, 

382 
Purchase     requisitions,    386,    chart, 

387 
Purchases     and     purchase     returns, 

in   accounting,   747 
Purchases,    standardization   of,    383 
Purchasing     (chapter),    373 
Purchasing  Agent  (magazine),  265 


8i4 


INDEX 


Purchasing  Agent,   211 

place  of,  in  business  organiza- 
tion,   373 
Purchasing,  competitive   system   in, 

393 

emergency  service  in,  393 
Purchasing  department,  381 
Purchasing,     follow-up    system    in, 

395 

inspection  in,  398 

Purchasing   power,    510 

Purchasing     power,     capitalization 
of,   591 

Pure   interest-rate,    always   theoret- 
ical,   764 

Purpose  of  business,   189 

"Pyramiding"  loans,   574 


Quality,  basis  of  sales  appeal,  421, 
425 

Quasi-monopolies,    no 

Quick    assets,    604 

Quota,    sales,   453 

Quotation,  nine  methods  of  in  for- 
eign trade,  515 


R 


Railroad  rates,  485;   Labor  Board, 

281 
Railway  accounting,  708 
Rate-making,  485 
Rate-of-service     wages,     289,     290, 

297 
Rates,  based  on  cost  of  service,  494 
based  on  "what  the  traffic  will 

bear,"  492 
carriers',  basis  of,  485 
carriers',   how   determined,  488 
commodity,   497 
express,    500 

fixed  by  public-utility  commis- 
sions,  685 
of     transportation,     factor     in 
selling  cost,  438 
Rate  of  exchange,  equalization   of, 
670 


Ratings,  books  of  credit,  562 
Reading  by  pages,  79 
Readjustments,    170 

after   panics,   573 
Real  accounts,  690,  699 
Real   estate  account,  700 
in  balance  sheet,  722 
loans   on,    630;    owned   by   na- 
tional  banks,  629 
Real   estate,  corporation   organized 

to  hold,  763 
Real  wages,  271 

Rebate,    on    payment    bills    of    ex- 
change, 666 
Recapitalization,    170 
Receivables,  in  accounting,  731 
"Receivables,"     in    credit    transac- 
tions,  588 
Receiverships,    173,    174,   739 
Record-keeping      in      management, 
2i8,  219 

in  modern  business,  686 
Records,  cost,  765 

in  line  organization,  194 
Recreation,  in  welfare  work,  47 
Red  tape  in  purchasing,  395 
Redeemable  bonds,   145 
Redemption  of  credit,  594 

of  Federal  Reserve  notes,  639, 
641 
Redemption     fund     against    green- 
backs, 639 
Rediscounting   of   Federal   Reserve 

bank's  paper,  636 
Rediscounts, 

defined,  643,  644 
Refunding  of  indebtedness,  148 
Regional  banks,  631 
Registered   bonds,   542 
Registrars  of  stock,  trust  companies 

as,  610 
Registration  of  trade  marks,  428 
"Regular"  trade  channels,  461 
Regularization  of  employment,  349, 

Regulation  of  carriers'  rates,  486 
Regulations,         Federal         Reserve 

Board,  655 
Reichsmarks,   rate  for,  674 
Rejected  shipments,  399 
Rent,  in  accounting,  750 


INDEX 


815 


Rent,    charge     against    income, 
762 

in  cost  accounting,  780 
Rentals,  on  balance  sheet,  738 
Reorganization,   170,   177 

committees,  181 

funds  for,    179 

management  under,    182 

technique  of,   180 
Repair  boss,  206 
Repairs,  in  accounting,  705 
Repairs    and    maintenance,    in    cost 

accounting,  781 
Repairs,  renewals  and  betterments, 

725 
Replacement  cost    (labor),   345 
Replacements  of  equipment,   in   ac- 
counting,   704,    706 
Reports,   contents   of,   223 
forms   of,   224 
rules  for,  223 
Requisition,    material,    766 
Requisitions,   posting  totals  of,   769 
pricing  of,   769 
purchase,  386 
Reserves  against  deposits,  636 
Reserves    against    Federal    Reserve 

notes,   636 
Reserve  against  notes,  641 
Reserve    banks,    reserves   of,    636 
Reserve  cities,  637 
Reserve,  depletion,  711,   724 
Reserve,    depreciation,    685,    705 
Reserve  districts,  632 
Reserve,  donation,  730 
Reserve  notes,   how  put  into  circu- 
lation,   643 
Reserve    requirements    of    Federal 
Reserve   Act,    suspension    of,    641 
Reserve    requirements    of    member 

banks,  637 
Reserves,    bank,    how   strengthened, 
636 

depletion  of,  641 

graduated  tax  on  deficiency  of, 

642 
held  in  New  York,  618 
Reserves  for  dividends,  165 

for    old    or    disputed    accounts, 

733 
Reserves,  secret,   751 


Responsibility'   of  manager,   242 

Rest  and  sleep,  330 

Restoration   of   reserves,   642 

Restricted  production,   indefensible, 
324 

Retail   Merchants'  Association,   563 

Retail    Stores,    manufacturers',   465 

Retailer  and  chain  store,  472 

mail-order     house     and     chain 

store,  478 
sales  direct  to,  465 

"Retainers,"   cost-symbol,    340 

Returned  goods,  745 

Revaluation  of  assets,  738 

Revenue  account,-  699 

Ricardo,     theories      of      rent      and 
wages,   50 

Rights,   of  capital,    labor   and   pub- 
lic,  189 

Rights,   stockholders',    133 

Ripley,   "Railway  Rates,"   123 

Risk,   financial,   mathematical   dem- 
onstration   of,    143 

Risk   and   profit,   243 

Route  clerk,  204 

Routing  office  work,  249 

Routing  an  order,  203 

Rowan  wage  system,  297,  299 

Ruble,  Mint  valuation  of,  669 

Rules  for  reports,  223 

Rulings  of  Federal  Reserve  Board, 
scope  of,   647 

of  Treasury  Department,   98 

Rural   credit   banks,   606,    611 

Rush   orders,    393 


Sakolski,    102 

Salaries,   in   accounting,  749 

Sale,  making  a,  443 

Sales  account,  692 

Sales  appeals,  basis  of,  425 

Sales  book,    entries   in,   695 

Sales,   cash    and   credit,    in   income 
statement,   744 

Salts,   computation   of,   in   account- 
ing, 703 

cost  of,  how  ascertained,  745 
direct  to  consumer,  461 

Sales  contests,  456 


8i6 


INDEX 


Sales  department,  208 

chart  of,   212 
Sales  districts,  212,  452 
Sales  manager,  district,  453 

division,  453 
Sales     manager      and      purchasing 

agent,   374 
Sales   manager    and   traffic   depart- 
ment, 213 
Sales  methods,   mail   order,  475 
Sales  organization,  452 

correlation  of,  455 

personality  of,  458 
Sales  quota,  454 
Sales  returns,  745 
Salesman,   responsibility  of,  426 
Salesmanship,   confidence   the   basis 
of,  441 

defined,  440 

distinguished     from     advertis- 
ing,  440 
Salesman,    responsibility    of,    456 
Salesmen,  advances  to,  732 

compensation    of,    464 

credit  information  from,   564 

deportment    of,   459 

m.anageirient  of,  451 
Salesmen's   conventions,    457 
Salvage  value,  in  depreciation  for- 
mula, 710 
Savings  banks,  606 

classes       and       functions       of, 
610 
Savings     funds,     legal    investments 

for,   610 
Schedule  boss,  205 
Schedules,  delivery,  383 
Schulder,   Fred,  on  catalogue  sizes, 

265 
Science  of  business    (chapter),    i 
Sciences    forming    environment    of 

business,   12 
Scientific  management,   207,  224 

cost  to  install,  222 

defined,  225 

in  office   work,   266 

origin  of  term,  226 
Scientific    management    and    labor, 

322 
Scientific   method    (chapter),    63 

application  of,  to  business,  2 


Scientific  spirit  in  business,   3 

Scott,  Walter  Dill,  449,  450 

Scrap   value,    767 

in  accounting,  706 

Scrip   dividends,    167 

Seager,   Henry  Rogers,   51 

Seashore,   "PsychologA,"   65,   68,   79 

Seasonal  businesses,  ratio  of  assets 
to  liabilities  in,  740 

Seasonal    variations   in   capital    re- 
quirements, chart,   131 

Secondary    reserves,    trade    accept- 
ance as,  649 

Securities,   marketed  by  investment 
banks,  607 

purchase    of    equivalent   to    di- 
rect loan,  604 

Securities,   when  to  sell,   144 

Selection  of  employees,  238 

Selection    and    training   of   employ- 
ees, 338 

Seligman,  "Economic  Interpretation 
of   History,"  34 

Seller,  objectives  of,  420 

Selling   (chapter),  411 
defined,  413 
high  cost  of,  414 

Selling  corporation,  463 

Selling  cost,  elements  of,  415 
analysis    of,    416 
of  mail  order  houses,  475 

Selling  costs,    affected   by   Sherman 
Act,   513 

Selling  efforts,  proportioned  to  pro- 
duction, 417 

Selling  expenses,  in  financial  state- 
ments, 749 

Selling     methods     of     competitors, 

Selling     price,      determination     of, 

430.   793  .       . 

determination    of,    with   aid   of 

cost  sys'em,  756 
elements  of,  416 
factors   in,  417,  418 
fixed    at    point   of   greatest   ag- 
gregate   profit,    432 
Selling  price   and   selling  cost,   420 
Selling  profit,  749 
"Selling  talk,"  450 
Semi-indirect  lighting,  251 


INDEX 


817 


Senses,    impaired,    factor    in    obser- 
vation, 66 

Serial   bonds,   150 

Service,  carriers'  basis  of  payment 
for,  489 

Service-life  of  assets,  707 

Service  wages,  289,  292 

Service  with  every  sale,  426 

Serviceability  of  product,  factor  in 
selling  plans,  424 

Settlements  with  creditors,  568 

Sherman  Law,   235 

Shipping  department,  213 

Shipping  documents,  ocean,  651 

Shipping  papers,  498 

Shipping   permit,    515 

"Shopping"  lines,  467 

Shop  work,  functional  organization 
in,  202 

why  standardized,  217 

Shop-worn    merchandise,    valuation 
of,  734 

Short-term  credit,  purposes  of,  604 
under     Federal     Reserve     sys- 
tem, 659 

Short-term  notes,  146,  752 

Silver    certificates,     retirement    of, 
638 

Silver,  in  settlement  of  trade  bal- 
ances, 638 

Silver-standard  countries,  exchange 
on,   680 

Single-entry  bookkeeping,  698 
defects  of,  699 

Single-name  paper,  620 

Sinking-fund    method    in    deprecia- 
tion calculation,    708 

Sinking  funds,    150 

Six     months'     agricultural     paper, 
642,  651 

Six    months'    drafts,    eligibility    of, 
645 

Skill,  "transference"  of,   321 

Slavery,  era  of,   9 

Sleep,  amount  required,   330 

"Slow-pay"     customers,     collection 

from,   567 
'  Sliding  scale,  295 

Small,  "General  Sociology,"  40 

Smart,    "Second    Thoughts    of    an 
Economist,"  53 


Socialization  of  industry,  49 
Social  science  of  business,  11 
Social  sciences  (chapter),  22 
Social     sciences    and    human    arts, 

24 
Social  sciences,  respective  fields  of, 

34 

shortcomings  of,  23 

Sociology,  38 

relation  to  business,  40 

"Soldiering,"     during     rate-setting, 
293 

Sole    proprietorship,    105 

Sombart,  "Quintessence  of  Capital- 
ism,"   121 

Sources   of   information   on   foreign 
trade,    511 

South  American   trade,    507 

Sovereign,  value  of  English,  669 

Space,  office,  248 

Spain,   exchange  on,   672,   675 

Special    agencies,   credit,   563 

Special  franchise,  728 

Special   marketing  conditions,    510 

Specifications,    buying    by,    3 

Specifications,   standard,   390 

Speculative  loans,  619 

Speculative  paper  ineligible,  643 

Speed  boss,  205 

Spencer,  Herbert,  38 

Spoiled    work,    penalty    for,    304 

"Square  deal"  in  employment  prob- 
lems, 342 

Staff    adjunct  to   line   organization, 

195 
Standard   labor-hours,  782 
Standard  report  forms,  258 
Standard  specifications,   390 
Standard  Statistics  Company,   16 
Standard  task^  227 
Standard  time  of  task,  309 
Standardization   of    labor   adminis- 
tration,   281 
Standardization,      a      function      of 
management,  420 
principle    of,    233 
of  selling  price,  431 
Standardization    by    motion    study, 

231  .     . 
Standardization  of  world  currency, 
683 


8i8 


INDEX 


Standardized  occupations,  310 
Standardized     operations,     in     cost 

accounting,   772 
Standards  of  business  ethics,  11 
Standards,  office  work,  249 
State    banks,    626 

requirements      for      joining 
Federal       Reserve       system, 

635 
restrictions  upon,  627 
State    banks    and    the    Federal    Re- 
serve system,  627 
Statement  of  charges,    519 
Statement     of    income,     profit     and 
loss,   in   bookkeeping,   692;    speci- 
men, 742 
Statemen's,  financial,   692 
Statistical   information,  supplied  by 

accounting  system,   695 
Statisticians,      American      Associa- 
tion of  Financial,  14 
Statistics,  science  of,  14 
Statistics,    studies   by   Prof.    Benini, 

42 
Stearns,  W.  S.,  311 
Sterling  exchange,   668,  669 

"pegged"  by  agreement,   674 
progression    in    rates,    673 
Sterling  exchange  and  dollar  cred- 
its,   680 
Stock,   classes   of,    113 
dividends,    167 
donated,    161 
issued  below   par,  729 
rights  to   purchase,   133 
selling  additional,   133 
sold  to  employees,  360,   363 
treasury,    729 
watered,    168 
Stock  cards,  769 
Stock    certificates,    not    true    credit 

instruments,    539,   542 
Stock     exchange     and    country     re- 
serves,  618 
Stock    exchange,    in    marketing    se- 
curities,   154 
Stock   ledger,   791 
Stock    market    prices,     in    business 

forecasting,    577 
Stock    records    and   physicaT   inven- 
tory, discrepancies  between,  769 


Stock  records,  inventory,  733 
Stock  savings  banks,  610 
Stock  sheet,  768 

specimen,  770 
Stocks    and    bonds,    in    accounting, 

733 
Stock-owning  bonus  plan,  364 
Stockholding,  consolidation  through, 

119 
Stockholders,  classes  of,  113 
Stockholders'  right,  133 
Storage    of    goods,    basis    of    bank- 
er's acceptance,  653 
Store    room,    arrangement    of,    767 
Stores  clerk,  766,  768 
Stores   returned   slip,   766 
Strikes,  278 

Subsidiaries,  condition  of,  how   as- 
certained,   753 
control  of,   118 
defined,  752 
financing,    140 
notes  receivable  of,  732 
Substitute     currency,      acceptability 

of,   641 
Substitution    of    collateral    securing 

acceptances,    653 
Suggestion,  429 

in   advertising,  408 
in    salesmanship,    450 
Suggestion    system,    200,    365 
Supply  and  demand,  control  of,  534 
Supreme  Court,  minimum  wage  de- 
cisions, 284 
Surplus   account,   how   created,   738 
Surplus,    current,    affecting    depre- 
ciation  charge,   710 
Surplus  and   div'idends,    161 
"Surplus,"     division     of,     in     wage 

payments,    301 
Surplus  of  Federal  Reserve  banks, 

633 
Surplus  and  reserves,  739 
Surplus,    used    for    dividends,    738 
Survival  of  the  fittest,  245 
Suspension      of      reserve      requircr 

ments,   641 
Sweden,  par  of  exchange  on,  669 
Syllogism,  business,  86 
Sy[idicates,     underwriting,     153 
Synthesis  of  task,  228 


INDEX 


B19 


System,  quoted,  223 
Systematized  management,  220 


"Talking     points,"     in     salesman- 
ship, 424 
Tariff  books,  497 
Tariffs,   railroad,  486 
Task  and  bonus  wage   plan,  297 

origin   of,   305 
Task,  construction  of,  307 

standard,    227 
Taussig,   F.   W.,    121,   602 
Tax  on  bank  notes,   596 
Tax     on     deficiency     of     reserves, 

642 
Tax  returns,  publicity  of,  286 
Taxation,  affecting  financial  plans, 

160 
Taxes  accrued,  737 
Taxes,  in  accounting,  750 

proration   of,   782 
Taylor,  F.  W.,  206,  227,  229 

"Shop    Management,"    92 
Taylor   differential   piece-rate,   297, 

301 
Taylor  system,  224 
"Taylor   system   in   Franklin   Man- 
agement,"  302 
Taylor-White    process,    231 
Temperature,  office,  251 
Terminal   charges,   734 
Terminal    receipt,    651 
Terms  of  mercantile  credit,  554 
Terms,  in  purchasing,  392 
Territorial   salesmen,  213 
Territories,     freight     classification, 

497 
Territories,  sales,  452 
Test  letters,  69 
Testimony,  in  acquiring  knowledge, 

79 
Thompson,   C.  Bertrand,  75,   77 
Tickler   file,   264 

Tickler   system,    in   collections,    566 
Timber,  depletion  of,  724 
Time  clocks,   772 
Time  and  cost  clerk,  205 
Time  and  motion  study,  228 


Time     deposits,     reserve     require- 
ments protecting,   637 
Time    loans,    617,    619 
Time   records  of  workman,   771 
Time   records   from   piece   workers, 

773 
Time  study,  288 
Time-study     engineer,     for     labor 

union,   309 
Time  wages,  289,  291 
Tipper,    Harry,    87 
Tonnage,   computation   of,    521 
Town   planning,    367 
Towne   wage-system,   298 
Trade    acceptance,    advantages    of, 
648 

agricultural,  651 

defined,  646 

eligible   for   rediscount,  644 

eligibility  requirements  of,  64S 

live-stock,  651 

opposition  to,  649 

in  open-market  operations,  657 

rediscounts  of  unlimited,  647 

seller's  contingent  liability  cre-r 
ated  by,  650 

specimen,    648 
Trade  Acceptance   Council,   647 
Trade,  balance  of,  670 
Trade    balances,    silver    shipments, 

to  settle,  638 
Trade  board,  314 
Trade  channels,  461 
Trade  discounts,  744 

in  accounting,  733 

rates  of,   555 
Trade  mark  association,  427 
Trade  marks   in   accounting,   728 
Trade  marks  and  trade  names,  426 
Trade       names,       of       mail-order 

houses,  473 
Trade  routes,   519 
Trade  unions,  bargaining  by,  313 
Trade   usages    affecting   dollar   ex- 
change, 655 
Trading    account,    692 
Trading  stamp  cases,    56 
Traffic    (chapter),   483 
Traffic,   through    rates,   493 
Training,     factor     in     observation, 
68 


820 


INDEX 


Transfer    agents,    trust    companies 
as,    6io 

Transfer   of  title,    in   credit   exten- 
sion,   592 

Transportation,  factor  in   plant  lo- 
cation,   185 

to  include  door  delivery,  480 
in  relation  to  market,  437 

Transportation  charges,  factors  in, 
491  ;   origin  of,  483 

Transportation    facilities,    analysis 

of,  437 

Transportation    tariff,    515 

Travellers'    letters    of    credit,    539, 
546 

Treasury    funds,    in    Federal     Re- 
serve banks,  636 

Treasury,     redemption    of    reserve 
notes   at,   639 

Treasury    stock,    161 
defined,  729 

Trial  balance,  695,  696 

Triangulation,  in  foreign  exchange, 
671,  676 

Trucks   in  transportation,  470 

Trustee,  in  bankruptcy,  568 

Trustees,  of  mutual  savings  banks, 
611 

Trust  companies,  606 
functions  of,  608 

Trust,  Massachusetts,   105 

Trust  receipt,  specimen,   551 

Trusts,  advantages  of,   no 

Turnover,  labor,  344 
cost  of,  345 

Turnover,  merchandise,  420,  748 

Typing,  standards  for,  249 


U 


Uncertainty,   factor  in   selling  cost, 

418 
"Under  New  Management,"  243 
Underwriting  syndicates,    153 
Unearned  burden,  782 
Unfilled    orders,    in    balance    sheet, 

741 
Unincorporated  banks,  625 

Unit  costs,  756,  760 
defined,  765 


Unit   of   production,   calculation   of 

cost  of,  756 

profit-sharing,  360 
property-cost,  724 
Unit  times,  229,   302 
Unity  of  control,   188,  322 
United  Drug  Stores,  471 
United     States    Children's    Bureau, 

283 
United      States     notes,      639      (see 

"greenbacks") 
United     States     Shipping     Act     of 

Sept.  7,   1916,   523 
Unpaid    dividends,    in    accounting, 

737 

Unsalable  stock,  740 

Usury  laws,  not  affecting  call 
loans,  617 

Usury  laws,  not  affecting  corpo- 
rations,  172 

U.  S.  Steel  Corporation,  housing, 
problems  of,  366 


Valuation  of  assets,  704,  721 

of  buildings,  725 

at  cost  or  market,  whichever  is 
lower,  733 

of  leasehold  rights,  723 

at  selling  price,  improper  prac- 
tice, 734 
Values,     "actually    existing,"    bills 

drawn  against,  646 
Variations  in  requirements  for,  128 
Velocity  of  circulation,  money   and 

credit,  602 
Vendors,  lists  of,  384 
Ventilation,  251 
Verification,    83 
Vertical  files,  262 
Vessels,  types  of,  519 

motive  power,   520 
Vetoing  stock,   115 
Viewpoint  of  management,  242 
Voting  trusts,   116,   182 
Voucher  register,  769 

W 

Wage     adjustments     in     collective 
bargaining,  315 


INDEX 


821 


Wage  board,  314 
Wage  of  contentment,  240 
Wage  equation,  Franklin,  303 
Wage,  minimum,  legislation,  284 
Wage    and    labor   policies   of  capi- 
tal, 277 

of    labor    unions,    279;    of    the 
public,  281,  283 
Wage  rates,  base,  302 

equalization  of,  312 

"reasonable,"  280 
Wage  system,  essentials  of,  307 
Wage  systems   (chapter),  287,  297 
Wages    (chapter),  270 

account,  in  bookkeeping,  690 

analyzed,  287 

bases    of    computation    of,    289 

defined,  287 

function  of,   310 
Wages-fund  theory,  50 
Wages,    limits  of,  272;    fair   wage, 

274 
Wages   not   an    economic   cost,    324 

real,  271 
Wallas,   Graham,   "The   Great   So- 
ciety," 14,  71 
Warehouse    receipt,    collateral    for 

eligible   note,   646 
Warehouses,  mail-order,  475 

manufacturers',  465 
War  Finance  Corporation  Act,  536 
War  par  of  exchange,  670 
Wasting  assets,  724 
Watered  stock,   168 
Water-way      transportation      rates, 
493 


Way  bill,  499 

Wealth,  the  stream  of,   53 

Webb-Pomerene  Bill,  481,  528 
summary  of,    514 

"Week    Work    Loss,"    expense    ac- 
count, 773 

Weighted-year    method,    in    depre- 
ciation, 709 

Westinghouse  classification   of  em- 
ployees, 311 

Westinghouse  filing  system,  261 

Whitehead,   Harold,  444 

White,  Maunsel,   230 

Wholesale   Cirocers'  Association  of 
Montana,  472 

Wilson,       Former       Secretary       of 
Labor,  241,  282 

Withers,  Hartley,  574 

Woodstock,   T.   F.,   701 

Work-day,  length  of,  331 

Work  in  process,  valuation  of,  734 

Working  capital,  defined,   125 

equalization    of    demands    for, 
603 

Works  manager,  211 


Yellowbacks,  641 


Zone  system,  L   C.  C,   501 
Zones,  parcel  post,  502 


This  book 


is  DUE  on  the  last  date  stamped  below 


FEB  2  9  193i 

JUN  8      193ib 


\   ••--'V 


MAR  ^1  'ite 

■■"'22  940)1 


f\\)6  6 


1957 


FormL-9-10m-5,'28 


IIP 

5351       C-erstenberg 
G32p5 

Principles   of 
business 


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